May 2001

FSA’s Director of GCD outlines to Chief Counsel A some issues to be resolved about Equitable’s draft actuarial report (received on 20/04/2001 [16:36]) for the compromise scheme. These include:

• Whether it is sufficient that the scheme should be fair to a particular group of policyholders as a whole, even if it was not fair to individual policyholders within that group.
• Whether the claim by Equitable’s solicitors is right that an option to purchase additional benefit was not material.
• Whether a single flat rate uplift of 25% for a particular group should be used when the value of their rights had been shown to vary from 14% to 30%.
• Why policyholders in group schemes were not treated as a separate class.
• Why the classes of policyholders had been determined the way they have.

[14:19] Line Manager E says to Chief Counsel A and Legal Adviser D that ‘it did strike me that [the Director’s] concerns about “fairness” may be overstated or misplaced, since I am not sure that “fairness” is strictly a relevant test’. [20:33] Chief Counsel A replies that the issue would be addressed in Legal Adviser D’s paper on the section 425 process.

[14:46] FSA’s Head of Actuarial Support notes that he had raised a number of issues with Equitable’s Appointed Actuary the previous evening. The Head of Actuarial Support reports that:

[Equitable’s Appointed Actuary] accepted the point that the assumed take-up proportions meant that those policyholders electing to take full GARs with no cash benefits and no spouses’ benefit could be seen as losing out. In practice, though, very few would decline to take the maximum cash benefit available since this could be taken tax-free. Moreover, he considered that their assumed current interest rate of 5.1% was lower than that available in the market for the most competitive current annuity rates (a point that we can look at further). If they assumed a slightly higher interest rate, then the corresponding assumed GAR take-up rate (to produce the same overall figures) would be rather higher.

I also suggested to him that they might like to look at applying financial option theory to value (1) the GAR option available at retirement and (2) the 3.5% guaranteed accumulation rate that policyholders are also being asked to renounce.

Regarding future movement in interest rates, he thought that this could be hedged by purchasing appropriate fixed-interest rate securities. I think this would protect the overall fund but it does still mean that they should adjust the offer to policyholders in line with the movement in interest rates.

The Head of Actuarial Support’s note continues:

Apparently, the take-up rates for group pensions are indeed rather lower than for individual policies (this is not a reflection as first thought of different early withdrawal rates). He believes that this relates mainly to the larger public sector schemes, as the smaller [schemes] behave similarly to the individuals. It was not at all clear to me why there should be this difference for larger schemes.

On a separate issue, they are looking to purchase a number of long-dated zero coupon bonds to hedge the overall GAR risk against movements in interest rates. I think this would certainly help the financial position of the fund in respect of accrued GAR rights but it still leaves a largely unhedgeable exposure in respect of future top-up premiums (the main source of the fundamental uncertainty mentioned in their 2000 report and accounts).

The Head of Actuarial Support then suggests ten points that should be pursued with Equitable, those being:

1) How have they determined that 5.1% is the appropriate long-term rate of interest to apply for all policyholders?

2) How do they believe that they could justify the assumed 60% proportion in the calculation of a “fair” offer for a policyholder taking all the annuity benefit in GAR form (and either maximum cash or no cash benefit)?

3) Have they considered applying financial option theory to value (1) the GAR option available at retirement and (2) the 3.5% guaranteed accumulation rate that policyholders are also being asked to renounce?

4) Why is the take-up rate for group schemes apparently much lower than for individuals? Does this relate mainly to larger [schemes]? If so, why do they think there is this difference in experience? Does it relate to differences in policy wordings? Is the choice in group schemes made by trustees rather than individuals?

5) Even with the assumed lower take-up rate of 40% (rather than 60%) for group schemes, why is the calculated uplift only 13.6% for group schemes rather than around 25% for individuals?

6) Will the overall package be affected by movements in the value of equity (and other) investments covering the GAR liability (the answer should I think be in the negative as they are offering a proportionate increase rather than an absolute amount of compensation)?

7) What is the reason for the strange pattern of figures (moving up and down) in the first column on page 16?

8) On a point of detail, what is the origin of the factor of “ten” for valuing each with-profits annuity in Appendix D?

9) Similarly, why are they applying the “MFR liability” to derive the value of certain pension plans on page 42 of Appendix D?

10) I could not understand the calculation, or the rationale for the calculation set out in Appendix I.

FSA write to PIA, with a note entitled ‘Equitable – disclosure issues’, following a meeting that morning at which they had discussed whether the disclosure of particular facts was expected under PIA Rules. FSA set out some thoughts on whether certain disclosures should be made and, if so, when.

[21:36] PIA agree that they should be looking separately at the two issues indicated by FSA.

PIA thank FSA for their comments on disclosure of the previous day. PIA explain that they would be considering the issue of whether ‘potential investors [should] have been told about the “problems” because it was an additional Risk factor in entering into the contract’. PIA say: ‘What is of interest is whether the position materially changed financially rather than just legally as a result of each court decision’.

[08:54] FSA say that their concern:

… has been around the question of what the PIA rules could reasonably be construed as requiring. My impression is that for a company adviser (ie one who did not have the freedom to offer products from a range of different companies), the issue is largely one of the suitability of the product type having regard to the circumstances, intentions and attitude to risk of the prospective purchaser. I think we will need to be very clear of our grounds (and of the precedents we will be setting) if we now construe the rules as imposing an obligation on the company adviser to advise on the financial position of his/her employer.

But going on from this, there may well be issues about what the company itself said about its position, or instructed its sales force to say. I wonder if here we are into a more complex area of the relationship between PIA rules and the common law.

[09:59] FSA say that they are considering similar issues in relation to another company and thought that ‘it would be useful to have a rather different “problem” case to test our thinking on the [Equitable case]’.

FSA’s Line Manager E writes to members of the Insurance Supervisory Committee about Equitable’s application for a section 68 Order relating to the calculation of interest rates for fixed interest securities, previously considered by the Committee on 17/04/2001. The Line Manager writes:

In short, the point at issue is the method to be used in determining the valuation rate of interest. The method required by regulation 69, which relies on a weighted average, is quite simplistic and can have some unexpected effects, particularly when companies do the resilience tests. Equitable would like a “concession” that requires a more sophisticated valuation method. Some other companies … already have broadly similar concessions. However, the [Insurance Supervisory Committee] questioned why the approach that the Equitable had proposed appeared less sophisticated than that adopted by the other companies.

Core members will also recall that as well as a change to the requirements on an ongoing basis, there was a need for a reporting concession in relation to the 2000 year end.

I have now taken the matter up with Equitable and the Society has said that, going forward, it would be content to follow a valuation basis that more closely corresponds to that used by the other companies mentioned above. (I should add that neither the Society nor I are entirely convinced that this approach is better, as opposed to different.)

However, it faces a practical difficulty in that it had been doing its calculations for last year on the basis that a concession as described in paper 179/2001 would be granted. It does not believe therefore that it is practicable for it to revisit the old calculations, particularly at a time when the Society is under huge pressures, including in trying to come up with a compromise scheme to deal with its GAR problems.

Conclusions and Recommendations

2000 Year end – I do not think we can require the company to recalculate its solvency going backwards. The choice is therefore one of approving what it has done and recommending a reporting concession on that basis, or requiring it to stick to the Regulations. [Insurance Supervisory Committee] members should be aware however that if they opt for the latter, it will require the Society to report a [unrealistically] weak financial position. This will be confusing for observers and may not be helpful to anyone. I recommend therefore that we should support the reporting concession.

Going forward – There are arguments that above all we should be seeking to achieve consistency in the valuation basis – at least in terms of what a company does from year to year – since it may otherwise select the most favourable valuation method at any given point. However, in response to [Insurance Supervisory Committee] concerns that I reported back, the Society has agreed to move to a basis consistent with that adopted by other firms. I would like more time to evaluate the arguments before deciding to go for one approach rather than another (ie the method proposed in the report concession or the more usual approach used by eg [an insurance company]). There are arguments either way, and we have time to look at those more carefully in the coming weeks.

If the core members agree that we can proceed with the reporting concession, I will come back with a further paper and draft order about what should be done going forward.

I have discussed this with [Scrutinising Actuary F] and [the Head of Life Insurance], who are both content with this approach.

[19:24] FSA’s Director of Insurance comments: ‘I look forward to seeing the committee’s views on this. To an untutored eye the case appears persuasive, particularly if, as I understand it, the approach the company has taken thus far reflects discussions with us. I certainly hope we can resolve this quickly. We and HMT would rightly be criticised if this got delayed and a negative decision taken by default’.

FSA’s Managing Director A asks the Director of Insurance where FSA were on Equitable’s 2000 returns, saying: ‘I saw something in the press last week about the end-year GAR allowance but have not seen anything providing an overview nor any commentary/recommendations on outstanding issues [of] valuation (which, knowing the Equitable there must be)’. The Managing Director says that Line Manager E had mentioned ‘reporting concessions’, adding: ‘I have to say that [FSA’s Chairman] and I are going to need to be taken through this all in detail and an idea of time and likely complexity would be much appreciated. I can forecast that we are likely to be very interested’.

[10:35] Line Manager E draws the Managing Director’s attention to his note of 30/04/2001 [17:13] and the fact that Equitable’s Companies Act reports and accounts had been published recently. The Line Manager goes on to explain that he is:

… hoping to get a paper together today on the reporting concessions for the statutory returns. The returns are due to be submitted by 30 June and we would normally expect them to be available at Companies House a few weeks after that. There is nothing to prevent the Society submitting their returns earlier or making their returns publicly available when they are submitted.

As to what they will show, the last headline figure reported to us by [Equitable’s Chief Executive] was that the Society had £300 million of surplus assets (ie after covering the solvency margin and resilience reserve). That took into account the benefit of the concessions being sought in relation to the valuation of Permanent Insurance (+ £100 m) and the yield on its fixed interest assets (approx +£200 m). Without the concessions things will clearly be very close.

However the above numbers … did not take into account the conclusions of discussions we had about assumptions on retirement age. GAD had been interpreting one of the regulations in a way that Equitable disagreed with. We looked at it further and have taken advice from Leading Counsel, and since concluded that Equitable was right all along. Equitable had in the meantime given up the fight and so had made the adjustment in its solvency calculations that GAD had asked for. The benefit to Equitable of our current position is a reduction in the reserving requirements of the order of at least £100 million. This should be taken into account when they submit the formal returns.

A member of the Committee replies to Line Manager E about Equitable’s application for a section 68 Order, in which he states:

I have to say that I am deeply uncomfortable about this. We have not yet seen any arguments justifying the method of calculation put forward in the paper, though I am prepared to accept that they may exist. It is not a method that has been approved for any other company. Without seeing a justification, therefore, we cannot give a concession to Equitable on the basis that it is something we would have given to any comparable insurer that asked for it.

This leaves us considering a concession on a rather different basis: that we have led Equitable to believe that they will get a concession in a particular form, that they have done their calculations on that basis and that, precisely because they are the Equitable, and therefore under huge pressures, we should not now require them to change.

I can just about swallow this, but it clearly does not meet the criterion you previously urged us to use when dealing with Equitable cases, which is that set out in my first paragraph. I’d be much happier if someone from Actuarial Support Department could set down why the “bundling” approach is a sensible way to proceed. If we could get some comfort that this is a reasonable approach in general, then we could take the view that we should be prepared to do this for any other company, and also that we should be content for Equitable to lock themselves into this method in the longer term (thus removing concerns about regulatory arbitrage between years). Would this really take too long to do?

[11:51] Another member of the Committee comments:

I generally agree with [the Committee member’s] comments.

I thought the point was that there were some circumstances where Equitable’s proposed treatment would work in their favour and other circumstances where it wouldn’t. So, surely this boils down to just two points:

•  are we (FSA) satisfied that what Equitable are proposing is in accordance with the real intention of the regulations? – I gather that we should be but, as [the Committee Member] suggests, I think it would be helpful to have some actuarial explanation of why the approach is acceptable;
•  that if we agree this approach then Equitable must stick to it – ie they can’t switch to a more favourable approach if this approach doesn’t work in their favour in future years. I think that this is the condition that both [insurance companies] had to agree to get approval of their approaches.

I’m not aware that we’ve previously said or implied that the solution developed by [the two insurance companies] are the only possible solutions. We presumably therefore think there is room for alternative solutions. As such, and provided actuarial support are happy with the Equitable proposal, I don’t see any reason to object to Equitable being granted the concession originally sought. Surely there is a big risk to the FSA if we “force” the company down the [other] route only to find that in a few years time that method has serious repercussions for Equitable solvency that the original proposal wouldn’t have had.

Re the last paragraph of the Detail, weren’t Equitable being a bit presumptuous in assuming they’d get a concession to do the calculation that way? Do we (or have we already done so) need to say something to them about that?

[11:54] Line Manager E replies:

There are two issues here – one of substance and one that is largely presentational.

On the substance, there is the question whether the approach originally suggested by the Equitable was better or worse than the approach used by [one of the two insurance companies], for example. From my discussions with our actuarial advisers, my understanding of what they have said is that they do not obviously see one methodology as being better than the other – they are just different. But either approach is preferable to the alternative of following the Regulation 69 method, which takes no account of the duration of the fixed interest assets. At no point in the discussions has the issue of the identity of the applicant influenced our conclusion that the Equitable’s methodology was acceptable. I am not in a position to provide the “proof” that you are after. However, I can honestly say that I am not aware of any reason why we should object to their original proposal.

In any case, that may no longer be an issue because after further discussion with the company, it has said it is perfectly happy to use the alternative [insurance company] approach if that is what we would like it to do. However there is a consistency issue with what they have been doing in the current year (to which I will return in a moment). As I think I explained, I have not yet been able to reach a view whether consistency with the approach adopted by some other insurance firms or consistency with what the company has done previously would be preferable. I think there are arguments both ways, and I will therefore return to that at a later date.

The more presentational – or maybe practical – issue is what we do about the 2000 year end. I think there is special pleading for the company about what it should do about its solvency returns for the year, at least to the extent that I am saying that a particular company faces a particular logistical difficulty and I would like us to be able to take that into account. My understanding is that there is no real reason to believe that the two methodologies are going to produce wildly different results. As [the Director of Insurance] commented, the company has in part been doing what it has on the basis of discussions it had had with us (inc GAD) over recent months.

In reality, there is a special case because the company is in a difficult financial position and is proposing a major financial reconstruction in order to sort out its difficulties. I think there are very defensible arguments for the FSA to take into account such factors – see for example sections 2(3) and 148(4) of [FSMA 2000]. If we were to apply a “risk model” to our use of various regulatory tools (as people talk these days) I would have to say that of all the things that we could ask Equitable Life to do at this point, getting them to redo calculations that relate to the past and that are of entirely academic interest comes a very poor second to requiring it to sort things out going forward. But in the meantime, I do not see that it is desirable (from anybody’s point of view) to require the company to report on the basis of a regulation that does not work as it was intended to – to do so would simply give a misleading impression about the company’s real financial condition in a way that will simply cause unnecessary anxiety for members of the public who are already very confused.

[14:52] The first Committee member explains:

I think that one principle to which we have clung firmly, and rightly, is that firms should not be able to change their valuation principles at whim, because of the risk of regulatory arbitrage this introduces. Consistent with this principle, it seems to me there are three ways forward for Equitable’s accounts:

•  Stick with Regulation 69 for 2000, and make a change for 2001 and subsequent years to whichever method on reflection seems best.
•  Move to the … method [used by one of the two companies] for 2000 and subsequent years.
•  Move to the “bundling” method for 2000 and subsequent years, subject to the actuaries being able to convince us that this is a sensible method for companies to adopt going forward. (I do think we need to see this justification, given that the two actuaries present at the [Insurance Supervisory Committee] meeting were not convinced.)
•  should be prepared to support any one of these three approaches. The fourth option, which I find less palatable, is to allow the “bundling” method for this year only, on the kind of basis set out in my earlier message. But in that case we could not pretend that we were treating Equitable as we would treat any other company.

[14:59] Chief Actuary C advises that:

I have noted that a request has been made for a view to be expressed by Actuarial Support on the Equitable’s application for a s68 Order. Although I am not fully aware of all of the arguments that have been aired on this matter I am sufficiently familiar with Equitable’s application to give our view.

I confirm that we are in agreement with the views expressed by [Line Manager E] as attached.

Equitable are seeking a s68 Order that would address an anomaly in Regulation 69 of the ICR94. The anomaly is described in [the paper submitted to the Insurance Supervisory Committee]. The request is to group the fixed interest assets into two blocks or segments (i.e. approved fixed interest stocks and other fixed interest stocks). The yield on each segment would then be calculated accurately as the rate which equates the discounted value of the aggregate cash flows arising on the assets in each segment to the market value of those assets. The interest rate used to value liabilities would then take account of these yields where approved and other fixed interest assets are hypothecated to match such liabilities.

Similar orders have been granted to [two insurance companies]. Those orders sought to address the same anomaly. In those cases the order permitted the company to hypothecate fixed interest assets (both approved and other) to match blocks of business and calculate the yield on the hypothecated assets in the same way as requested by the Equitable. In the [first company’s] case the order provides for the one block of business that exists (i.e. annuities), whereas in the [other company’s] case the order enables the actuary to identify more than one block of business and hypothecate assets more appropriately to match liabilities with different characteristics.

For the 2000 year end, the Equitable order effectively assumes only one block of business exists (i.e. the [first company’s] approach). In practice the Equitable would have been better advised to [have] adopted the [other] approach in order to address the different types of business that exist. However the Equitable consider that their request for an order that splits the fixed interest assets into the two segments, as described above, is a pragmatic half way house to the theoretically ideal solution (i.e. the [other] approach). We have been told by the Actuary that the difference in the liabilities assessed on each basis is not material based on modelling that they have undertaken.

We recommend that you accept the request made by the Equitable. We are told that Equitable would be prepared to adopt an approach similar to that used by [the other company] in future but that it is administratively inconvenient to adopt that approach at this stage for the 2000 returns.

[15:37] The Committee member concedes: ‘If [the actuarial member of the Committee] and [a special adviser to FSA] are convinced by these arguments I should be prepared to go along with the bundling approach, but on the basis that Equitable must then stick with it for a period of years’.

[15:47] The special adviser states that: ‘Given the two precedents, I am content. Perhaps we should treat it as a priority to change [Regulation] 69 and our Actuarial Support could start discussing a consultation document for issue later in the year’.

[16:12] Line Manager E distributes a note to Managing Director A on the issues, saying:

Thank you to all those who have contributed to the debate. In the meantime I have discussed this further with Equitable Life and – as you will see from the [optimistically drafted] draft memo to [the Managing Director] attached – been given information that leads me to conclude that the returns will not be materially different whether they use the Equitable segmented approach or the [two insurance companies’] method – either way will reduce the reserving requirement by somewhere in the range £150-200 million (compared with a total of £29 billion).

Reporting for 2000 on the [two insurance companies’] basis is simply not on. So the first question is do we allow the Equitable to report on a more accurate basis than it would if it complied with regulation 69. [The special adviser] and [Chief Actuary C] (and [the Director of Insurance]) are arguing in favour.

There is a separate question about what should happen for the future, and that is of course not one that I had asked. I have noted that, while I fully support the consistency argument, regrettably, whatever we require will produce some consistencies and some inconsistencies. I am not yet in a position to take a view as to whether going forward we should go for consistency between firms or within one of them. There are arguments both ways and I thought I had made it clear that I would want to consider them carefully before making a recommendation to the Committee. I do not therefore think I can proceed with a conditional agreement as proposed by [the first Committee member] – namely that the Committee should only give approval provided the same valuation basis is used in future years.

[17:15] The first Committee member adds:

I know I’m being difficult on this case, but you did say at the [Insurance Supervisory Committee] that a major criterion in considering any request from the Equitable should be whether we would grant that request if it came from any other company. We have also established that our policy in relation to other companies is that they should not have freedom to shift the basis of valuation from year to year.

If I were dealing with a company X, therefore, my starting point, following resolution of the technical issues around bundling, would be that they have 3 choices:

•  They can stick with Regulation 69 (and possibly seek a change at some time in the future).
•  They can shift to the [first company’s] basis now, and stick with it.
•  They can shift to the “bundling” basis now, and stick with it.

If the request came late in the day, after preparation of the accounts was well advanced, I should say rude things about the company’s management, but I might be persuaded to let them use the bundling basis for one year and then switch to the [first company’s] method, provided that they had no discretion in the matter (so that the question of regulatory arbitrage would not apply). I should not be willing simply to postpone the decision about what would happen after the first year.

So much for company X. I recognise that the circumstances of Equitable are special and that both management and supervisors have had other things on their minds. If you want to put your recommendation to [Managing Director A] on the basis that Equitable is special, and that we are justified in doing (relatively minor) things that we would not do for another company, I shall not die in a ditch. But all concerned will need to be clear that that is indeed the basis of the argument.

[17:30] The Director of Insurance responds that: ‘Surely the key to this is that it should be FSA, rather than the [Equitable], who should determine which form of consistency is the more important – ie, whether we are more concerned about consistency between years or consistency between companies. The [Equitable] will always have the choice as to whether to apply for any form of this concession. Provided that they are aware that we may not be prepared to grant... exactly the same concession next year, and conversely that we might not be prepared to let them move to the other version, then I see no particular problem. And since, in any event, we cannot fetter our discretion, pointing out that we are reserving our discretion in this particular way ought not to cause them, or us, any grief’.

[17:32] The first Committee member says: ‘I think this was roughly where [Line Manager E] and I had got to in some off-line discussion’.

[17:41] The Director of Insurance says that this is: ‘Excellent’.

[18:12] Line Manager E sends Managing Director A a final paper on the two section 68 Orders applied for by Equitable. The Line Manager explains that: ‘Achieving internal agreement to the position (on the second of the concessions about yield calculations) has taken some time but I believe we have now reached a position all are comfortable with. The reason for an element of doubt in the last sentence is because I have not had confirmation from the requisite quorum of [Heads of Department] and managers. There are however no dissenters and I thought it best not to delay until next week’.

The paper explains that both concessions had been looked at by FSA’s Insurance Supervisory Committee and that this reflected the position agreed by that Committee. On the valuation of Permanent Insurance, Line Manager E sets out the sequence of events of the sale of the company and the conclusion that: ‘We consider that as the sale was confirmed, the agreed sale price provides a sensible basis for a valuation of this asset. We believe that equivalent concessions, requiring a proven market valuation to be used, have been given in other similar circumstances. It is also not unusual for a requirement to report on a particular basis to be imposed after the event, provided that the requirement is imposed in advance of the reporting date’.

On the other section 68 Order, the paper sets out the following:

Regulation 69 of the Insurance Companies Regulations 1994 specifies the basis on which future payments are to be valued. In effect, the requirement is to assume an interest rate no higher than the average yield currently being achieved on the assets supporting the long term business. The regulation specifies how that yield is to be calculated. However, there is a slight defect in the averaging method prescribed in the regulations which means that depending on economic circumstances they can place (and at the moment they are placing) an artificial strain on the company (or lead to an artificial release of reserves). This arises because of the simplistic basis of the calculations for fixed interest assets, which averages the rates interest by value of the underlying investments, but takes no account of their duration. At the time the regulations were made, more sophisticated calculations were not thought possible.

The problems with the valuation method in regulation 69 become evident when doing the calculations for resilience test 2. Many companies just live with the consequences. However some have preferred to report more accurately (including [two insurance companies]) and have therefore been given section 68 orders requiring them to perform more sophisticated calculations. Equitable Life has asked for a similar concession.

Their original proposal was to calculate the yield on the basis of two segments of fixed interest securities (approved and non-approved). This is slightly different from the methodology that has been applied by other companies. Following discussion at the [Insurance Supervisory Committee], I have gone back to the company which has since agreed that for future it would be willing to use the approach that has been adopted by other firms. That alternative methodology effectively involves the company seeking to hypothecate blocks of fixed interest assets to particular areas of business in order to calculate the yield.

For the last financial year, Equitable Life does not believe it is possible to rework its past calculations on the “third” way (or at least it says that the work involved in so doing would be disproportionate). This is unfortunate because ideally we would have liked the reporting concession for the year end 2000 to have been consistent both with what the company was proposing for the future and what certain other companies are already doing. I have discussed the effects of the different approaches and the company has indicated that (at least with current economic conditions) it believes the financial effects of either methodology would be broadly similar, although the “third way” might produce a very slightly less favourable result. If Equitable Life goes ahead on the basis it had proposed the benefit to its solvency position will be of the order of £150-200 million as compared with the regulations. The company’s actuary believes that the third way would also have produced a benefit within that range.

After some debate, we have concluded that it would be appropriate to allow the Equitable Life to report the end 2000 position as it has proposed. This produces a more accurate reflection of the financial position than would be the case if it followed the requirements of regulation 69. We have also concluded that it would be unrealistic, and an unnecessary distraction, to require the company to rework its historic calculations. It is worth remembering that Equitable Life’s actuarial team [is] central to the work on the compromise scheme.

However, that leaves a problem for the future. As noted above, it was our preference that the valuation basis used by Equitable Life was consistent with what is done by other companies. On the other hand, it is normally a requirement when such concessions are granted that a company has to continue to use the same valuation basis in future years, so that it cannot select the method that is most favourable at any given point. The evidence suggests that it will be possible to go for the former, without being overtly inconsistent, in numerical terms, with the Society’s track record. There is certainly no question of the Society trying to select the most favourable basis from year to year. I will look further at the issue of the approach for the future valuation basis, which can be the subject of a separate order (or a rule waiver).

At this stage, I therefore would welcome your agreement that we should recommend

to the Treasury that a section 68 order should be given to address [only] the 2000 reporting question.

[19:01] FSA’s Managing Director asks the Director of Insurance and the Head of Life Insurance for a meeting to discuss the applications, saying: ‘to me concession (1) is unarguably right (2) more difficult. But more generally I would like before we go snap on anything reassurance that all other solvency/reserving issues between [Equitable] and us have been resolved totally as we would want them. I recall a note from last November that said as that stage there was some £1bn difference between us and them overall on the reserving question. What has happened to all of that?’.

[19:10] In response to Line Manager E’s note to the Managing Director, Chief Counsel A says that she would be surprised if there were ‘any significant legal issues arising here’ but that she would review the papers the following week.

FSA send Director of GCD’s comments of 01/05/2001 [10:55] to their legal advisers and to Counsel, for information.

[16:33] Chief Counsel A queries with the Director of GCD whether FSA should send the comments to Equitable and inform them that they raised ‘major’ issues.

[18:40] The Director says that they should be sent to Equitable pretty soon as they were all or nearly all points of substance, while making it plain that FSA had not yet reached concluded views on them.

[15:53] Equitable’s solicitors send FSA some information about their Articles of Association relating to the election and required numbers of directors.

[16:24] Legal Adviser D forwards the information to other officials at FSA, saying that the note cleared up some of FSA’s knowledge gaps; the important point being that there would continue to be eight directors.

[18:26] In response to a request for some information for FSA’s Board on Equitable’s Companies Act reports and accounts, ‘particularly as … much has been made of the increase in the reserves figure to [greater than] £1.5bn’, Line Manager E provides the following:

Equitable published its annual report and accounts in the week beginning 30 April. From a regulatory perspective, they show little of interest since we have much more up to date information about the Society’s financial position. However, it is helpful that the report give some useful information about the valuation of a life office’s liabilities, and in particular an explanation of the development of the Society’s GAR liability during the court process, and subsequently. Equitable is due to submit its regulatory returns for the end of 2000 in June.

Line Manager E says that: ‘Unless [the Head of Life Insurance] can think of anything more useful to say. I feel a bit nervous saying that the statutory accounts don’t tell us much, but I think in this case it is true!’.

An FSA official tells Line Manager E that his note for the Board of 03/05/2001 [18:26] would not do, as it ‘omits to mention [Managing Director A’s] key concern which I alluded to … i.e. the figure quoted for gross liabilities and why this is different to the number that has previously been quoted i.e. £1.5bn’.

[10:36] The Head of Life Insurance amends the statement to read:

Equitable published its annual report and accounts in the week beginning 30 April. From a regulatory perspective, they show little of interest since we have much more up to date information about the Society’s financial position. However, it is helpful that the report gives some useful information about the valuation of a life office’s liabilities. In particular it explains clearly why the technical provisions in respect of the GAR liability increased from £200m in 1999 to £1.668bn in 2000 (made up of £1.468bn for the GAR provision, and £200m for the GAR rectification scheme). This significant increase in the provision reflects the impact of the House of Lords’ decision. The provision included at 31st December 1999 was set assuming that either the Court of Appeal or the High Court decision would be upheld. The House of Lords’ decision went further than the Court of Appeal’s decision and prohibited “ring fencing” of GAR policies. Equitable is due to submit its regulatory returns for the end of 2000 in June.

[12:36] The FSA official later confirms that this amendment had addressed the point about which the Managing Director had been concerned.

[12:46] FSA’s Head of Actuarial Support adds that: ‘The report and accounts does also provide some detailed explanation of the derivation of the different figures for the value of the GAR option. For example, the increase in technical provisions from £200 million to £1.67 billion only relates to the figure in the Company Act accounts and not to that in the FSA returns’. He also adds that: ‘There are also some relevant comments about the fundamental uncertainty attaching to this figure. This relates, I believe, primarily to the issue of the level of future premiums that may be payable but also to potential future changes in long-term interest rates (though we understand that [Equitable’s Appointed Actuary] is recommending to them some form of limited hedging of this latter risk). There is also the uncertainty of the effect of possible future legal actions’.

[09:00] FSA’s Head of Life Insurance replies to Managing Director A’s suggestion of a meeting to discuss Equitable’s section 68 Orders, saying:

In brief, Equitable have accepted our position on the £1bn, so although the position is tight (£300m free assets) and subject to two concessions from HMT, there is no outstanding disagreement between us and [Equitable].

[10:47] The Managing Director says that he had talked to FSA’s Chairman about this and that they had agreed that this would be especially sensitive if:

… giving the disputed concession (he agrees the first is fine) is the difference between solvency/non-solvency or makes a near-zero level look rather better. So by the time we meet early next week can we [please] (not closer than one or two tens of millions) have an idea of what the position is. My own understanding is that without either concession the outcome is a near “zero” surplus possibly even a deficit, while if the first concession is given but the second one not, the surplus is of the order of £100mn (i.e. very close for comfort)

On the substance of the 2nd concession, [the Chairman] feels that my fudge won’t do and that the real choice is between no concession or getting them to do it [properly] if they are so desperate to have it. He also asks why is it that other firms have bothered to go down this route of greater complexity when they themselves have a sizeable surplus however the numbers are calculated. If there [were] a good reason it might help to dissipate the idea (perish the thought) that Equitable are doing this only through desperation.

[11:59] The Director of Insurance expresses concern that the Managing Director was implying that Equitable were not ‘doing it properly’. The Director of Insurance says:

I don’t think that this is a fair representation. They are not doing it the way other companies have. But as I understand it, the way they are doing it has come out of a dialogue with our actuarial advisers who advise that, from a technical perspective, the request should be met. Clearly we need to be careful that we do not do favours to the Equitable in the sense that we are not unreasonable in refusing a concession on the basis simply that it is not in the form in which it happens that others have previously sought it.

No doubt [the Head of Actuarial Support] and/or [Chief Actuary C] can advise. But I don’t think that there is any major significance to be attached to the fact that other companies have previously adopted a less complicated approach. Perhaps simply a refinement of actuarial thought both here and in the Company?

[16:23] Scrutinising Actuary F writes to the Head of Actuarial Support with a draft response, intended to clear up a number of points. He comments that the section 68 Order sought by Equitable (and given to other companies) was seeking to correct what he explained was a ‘flaw’ in Regulation 69.

The Scrutinising Actuary also comments on Equitable’s solvency position at 31 December 2000 and the latest position. He says:

The Society have told us that at 31.12.2000 they had excess assets of about £500m., after meeting their required margin of solvency. This anticipated both an Order in respect of the valuation of Permanent (worth about an extra £125m.), and an Order in respect of the treatment of the fixed interest assets (worth about £150m - £200m.). Without these Orders, the excess assets would be about £200m.

Markets have been volatile during the year to date. We understand that at end-January the position was somewhat better than at 31.12.00, and excess assets amounted to around £700m. At end-February, however, the position was somewhat tighter. Then on 01 March the Society received an injection of £500m. from the Halifax, which boosted the position accordingly. (In fact, the Society told us that this injection improved the free assets by more than £500m., because of some secondary benefits elsewhere in the valuation).

To summarise, the position at 31.12.2000 would have been excess assets of the order of £200m., rather than zero, were neither of the Orders granted. Both approaches to the fixed interest stocks (as at 31.12.00 and as at 31.12.01) are acceptable; the Society’s proposed approach to 31.12.01 reflects our discussions with them last week, and there really is not time to ask them to rework their calculations at 31.12.00 on the 2001 basis, given the impact this would have on their workload.

Another member of FSA’s Insurance Supervisory Committee comments on the discussion the previous day, having discussed the matter with some of the officials. The Committee member says that he is:

… broadly content, but remain concerned about the “consistency” concept. [Equitable] must tell us their intention. If it were any other company applying for any S68 we would want to know their future strategy (intention). In return we would indicate our intention. I have no problem with the options but it is for [Equitable] to say to us what is the most appropriate treatment technically (thus avoiding the problem of switching to most favourable). If they say the [first company’s] method is technically the most correct but they cant do till next year then fine. Allow bundling this year and expect a switch next year. If bundling is correct then expect this consistently.

[11:48] Scrutinising Actuary F says that Equitable had informed FSA of their intention in their letter of 30/04/2001 [14:04], and that this was:

… to group their fixed interest securities into two blocks, or “segments” (one block to comprise gilt-edged securities and the other to comprise other fixed interest stocks, e.g. loan stocks & debentures) for the valuation as at 31.12.2000. For the valuation at 31.12.2001 they will group the securities differently to match specific major blocks of business (e.g. they will allocate one “basket” of assets to support their annuities in payment, and a separate “basket” to support other business. Each “basket” would comprise for example x% gilts, y% other fixed interest, z% cash, where x+y+z=100%).

They are adopting the “segment” approach for the 31.12.2000 valuation, because it builds on how the assets are reported on Forms 48 & 49 of the Returns, and retains the distinction between gilts and non-gilts. [The Chief Actuary’s] e-mail yesterday describes how the Society intend to use these segments in their 31.12.00 valuation. GAD previously reviewed this approach and were content with it.

However, at a recent meeting at FSA on 23 April … FSA … said it would be preferable for the Society to adopt an approach consistent with other companies which already have similar concessions.

Therefore Equitable have said in their 30.04.01 letter, referred to above, that they will change their approach for the future, as described above.

As [Line Manager E] explained in his first e-mail, it is impractical to ask the Society to rework their calculations in respect of the 31.12.2000 valuation at this late stage. The impact on their internal [computer] systems, mainframe systems and reporting systems, timetable for auditing the returns and so on would be more than I believe they could accommodate. Equitable’s stated intention to change their approach for the future reflects what FSA have asked them to do.

The first Committee member notes what the Scrutinising Actuary had said. The Committee member says, however, that he believed that Line Manager E’s submission to Managing Director A and his comments the previous day ‘makes it clear that we at any rate have not decided what approach we will support going forward, and I had assumed that reaching a decision on this point would be likely to involve some discussion with the company’.

FSA meet Equitable’s Chairman. The Chairman provides FSA with a copy of their Counsel’s joint opinion on whether it was possible to change the House of Lords’ decision, and on the possibility of mis-selling claims to be made by non-GAR policyholders. (Note: it appears that no note of the meeting was made.)

[12:40] Following the meeting, FSA hold a further meeting to discuss the work that they needed to put in hand. The Director of Insurance reports to Managing Director A that:

Broadly speaking this fell into the following groups:

a) Was there any reason why Equitable should not publish a summary of [their Counsel’s] opinion. It might arguably be inconsistent with the directors duty to act in the best interests of the company. It might prejudice the work [solicitors] are doing to investigate the possibility of action against the company’s advisers;

b) What were the implications for the company’s solvency under the Companies and the Insurance Companies Act. The former was primarily an issue for the directors. But the latter was an immediate issue for us. Either way we needed to know, on whatever basis, whether the answer to the question “Is the company solvent?” is changed, or called into doubt, by the opinion;

c) What were the implications for our responsibilities for other companies. If the sense of the opinion was, essentially, that writing non GAR policies in a fund which also contained GAR policies, without disclosing the potential cross-exposure amounted to misselling under LAUTRO and PIA rules (as well as misrepresentation) then the question arose whether other companies were also similarly exposed. The issue for us would be whether other companies had been guilty of misselling and, more importantly, were they still misselling. If the latter we needed to consider what action we might appropriately take to prevent this;

d) What the reserving implications might be for other companies;

e) Whether any of this had implications for the application of the MVA (primarily by the Equitable, but perhaps by other companies)

We will be seeing [Equitable’s Chief Executive] tomorrow morning. We needed to address the reserving and solvency issue with him at that meeting.

The Director of Insurance also reports that:

Following this discussion I spoke again to [Equitable’s Chairman], primarily to ensure that [the Society’s Chief Executive] was fully in the loop, but also to discover how firmly committed the Equitable felt to early publication of a summary of [their Counsel’s] opinion. [The Chairman] told me that [the Chief Executive] was now fully briefed, had read the conclusions of the [Society’s Counsel’s] opinion but not the opinion in full. He agreed that the reserving and solvency issues needed to be addressed urgently and would warn [the Chief Executive] that we would be raising these with him. On early publication he felt that the Equitable had no option on this. They had discussed this with [their solicitors] this morning who saw no obstacle of the sort we envisaged. The opinion was already the subject of leaks; [Counsel] himself had drafted it in the expectation that it would be published. It was clear that it would have to published at some point and it was not clear that anything was to be gained by delay. Preliminary discussion with some of the directors (there is to be a fuller discussion tomorrow morning) had resulted in agreement on this point. In the Equitable’s view the opinion raised fundamental issues which would need to be settled in court before progress could be made. In terms of publication the key sensitivity would be what the Equitable themselves said about the opinion. Their present view was that they would say that the opinion raised issues of great complexity, that they were considering these carefully, with a view to testing the conclusions expressed in the opinion in the courts.

On timing, [the Chairman] said that they would not publish before late tomorrow afternoon, but that they would probably not hold much later than that. They would ensure that we received notice, together with a draft of what they planned to say. But, despite my protestations, he did not promise that we would get much notice. I said that, given our own concerns about early publication, we were bound to ask ourselves whether this was appropriate or whether, if we concluded that it was not, we should take formal action to prevent it. I thought this “very unlikely”, but thought in all the circumstances that it was right to let [the Chairman] know that the possibility existed. [Equitable’s Chairman] said that he would assume that we were not minded to do this until such time as we told him otherwise.

The Director of Insurance then suggests to the Managing Director the action that FSA needed to take, saying:

All of this suggests we will need to get our ducks into a semblance of a row pretty quickly:

We need to decide very quickly indeed if there are grounds for our intervening to prevent early publication and, if so whether we should do so, (bearing in mind that we would almost certainly need to make this action and the reasons for it public). [Managing Director A]: if immediate action on this is needed it is likely to fall to you to take the decision. You may need to consider whether you should stand aside from the preparatory “investigation” which might lead up to this.

[FSA’s Head of Actuarial Support], with legal support, will lead the work on reserving. But this cannot be progressed very far until we have studied the opinion – and we may well need Counsel’s advice ourselves;

[Chief Counsel B] (with [PIA], to whom I have not yet spoken) will consider the issue of possible misselling by other companies. In practice we should not allow ourselves to be stampeded into anything by an as yet untested opinion. But we will need a holding line at least, and to decide what work we should put in hand. (You had suggested earlier that this raises the issue of whether we should suspend/change our own investigation of possible misselling by the Equitable);

[Chief Counsel A] will “warm up” [Counsel] on the issues, primarily to take his mind on whether there are other important issues or questions that we have not identified.

[13:15] The Managing Director replies, having spoken to FSA’s Chairman. Managing Director A says: ‘We do not think there is any basis on which we could seek to prevent/delay publication of this report – a fortiori in the light of the view taken by [Equitable’s solicitors] that it does not affect their work. We would be grateful if you could pull out of [an overseas conference of regulators]’.

FSA’s Director of GCD provides the Director of Insurance with a note on the opinion of Counsel for Equitable. The Director of GCD says:

I have not yet read the opinion myself, but on the basis of the description given to us by [Equitable’s Chairman] this morning, its conclusions are that:

•  attempting to get the House of Lords to change its original decision is “a dead duck”;
•  however, non-GAR holders have alternative causes of action which could be taken to counterbalance the rights of the GAR holders.

It is suggested that the non-GAR holders have three possible causes of action, that is, for:

•  breach of Lautro rules, which it was said provides absolute liability, under which it is not a defence to show that you misunderstood the position;
•  misrepresentation in failing to disclose the true position;
•  breach of an implied warranty that non-GAR holders would receive a certain share of the assets.

Possible implications we need to consider are:

•  impact on the proposed section 425 scheme: the implication seems to be to support the argument for bringing these liabilities into account into the Section 425 scheme, but it is recognised that further consideration will need to be given to the degree of certainty/ascertain ability that the Court will require for this purpose, particularly the level of impact on different individuals, rather than groups as a whole with implications not least for the scope and timing of the scheme;
•  the need for provisioning against these liabilities: while in the context of the compromise, they may be seen as counterbalancing the rights of the GAR holders, we need also to consider them as potential claims against the company which could potentially increase its overall liabilities and to determine the approach which needs to be made to provisioning in that light;
•  the provisioning issue needs to be regarded as urgent both because of the need for the Equitable to produce statutory returns, and because of our own need to respond to questions when the opinion goes on to the Equitable web site later this week;
•  there are also issues in relation to other companies which have sold GARs: what approach should be taken to provisioning in their accounts, and should any action be taken in relation to ongoing sales which they make?
•  the analysis in this opinion needs to be factored into the work on duties to disclose on which we have concluded we should seek external counsel ourselves, and also borne in mind in considering the draft PIA disclosure report;
•  we need to return rapidly to [Counsel] for further advice in relation to Article 4 of the Equitable’s constitution;
•  we also need to look at the implied warranty analysis to see whether there is anything in it which affects our approach in relation to the MVA, which colleagues are looking at in the context of our contract terms responsibilities.

There was one other point which was raised at today’s meeting which is worth noting in this context, though it does not arise directly from the opinion. This relates to the work which [Equitable’s solicitors] have been asked to do to look at the claims which the Equitable can make against others. The meeting identified the fact that this work would potentially have an impact on the Section 425 scheme. On a straightforward view, any additional assets recovered in this way would simply be available as additional assets of the company. However, there was a counter argument that duties were owed, and loss suffered, specifically in relation to the non-GAR policyholders. If this was the case, this too would arguably need to be brought into account in the Section 425 scheme. Presumably, this would need to be brought into account by providing in the scheme for any sums received by this route to be allocated to non-GAR policy holders, but even then it would still be tricky to work out exactly how the prospect of such credits would impact on the amount of the settlement overall.

An FSA official distributes a note of a conversation that FSA’s Chairman had had with Equitable’s Chairman the previous evening, while attending a dinner hosted by a recruitment and management assessment company. The note records:

[FSA’s Chairman] spoke to [Equitable’s Chairman] at a dinner last night and asked about whether he had considered disentangling the [Counsel’s] opinion so that the parts about not being able to challenge the House of Lords could be released but not the sections saying on LAUTRO rules. [Equitable’s Chairman] had considered it but had found that it would disrupt the logical flow of the argument and that it would all be exposed by the non-GARS the moment the Court considered a proposed arrangement so it was better off getting it out into the open now. [Counsel] had put forward a much shorter version but Equitable had felt this had only served to make the issue look much more stark. [Equitable’s Chairman] expects that Equitable, [Counsel for the Society], and colleagues to do the further work that they recommend.

Equitable planned to put out a press release on all of this, probably today. They would send us a copy prior to it being released (which we presume will be handed over by [Equitable’s Chief Executive] this morning). [FSA’s Chairman] would like urgent thought to be given to how we would respond, which we presume will be along the lines that we would be studying the opinion carefully [action – [FSA’s Head of Press Office] and interested parties].

[FSA’s Chairman] asked what form he would want a Court decision to take. [Equitable’s Chairman] said that he was looking for a [declaratory] judgement, but would like to have an early discussion with us about our views on how they should proceed. We need to give immediate thought to what our line should be. Clearly, there is a risk that a Court might say that the proper course of action was for a policyholder to take a case to the Ombudsman and then, if they wished, to seek judicial review. we need to consider how this relates to complaints the Ombudsman has already received (of which there must be many, one would presume) and also whether we should be considering any action ourselves in this area [action – [The Director of GCD] and interested parties]. We also need to give consideration to how the consequences might affect Equitable’s solvency (which was not a point [Equitable’s Chairman] had focused on) [action – [The Director of Insurance] and interested parties].

He said that he hopes to persuade [Halifax’s Chairman] to extend the timetable for the Halifax deal, if necessary ([FSA’s Chairman] is sceptical about the likelihood of this, especially if it is an open-ended commitment).

FSA’s Chairman later (on 21 May 2001) provides a ‘Note for Record’ of the conversation.

FSA meet Equitable to discuss the opinion given by Counsel for Equitable.

Equitable confirm that Counsel ‘had been given a fairly wide and open ended brief by the Society to look into the House of Lords ruling’. On the first part of the opinion, FSA record:

It appeared that the draft opinion ruled out challenging the House of Lords verdict on the basis of process, conflict of interest or lack of representation for non GAR policyholders. The [House of Lords’] judgement was here to stay, although there was still considerable doubt as to how this ruling could be interpreted. [Equitable’s Chief Executive] had referred in an early meeting to allocating bonuses on a calendar year basis. This approach could recognise the extent to which pre 1988 policies had GAR options when setting overall bonus levels. Although it could be argued that such an approach was attempting to frustrate the [House of Lords’] judgement – but [the Chief Executive] thought that other companies operated in this way.

On the second part of the opinion about non-GAR policyholders, FSA record:

[Counsel] appeared to advocate that non GARs may have either a contractual right to receive full asset shares or a case for mis-selling … because of the lack of disclosure on GARs. This part of his opinion needed further work. It was recognised that these interim conclusions could be damaging to the 425 process as they would lead the non GAR pressure groups to press for the halt of the transfer of value to the GARs. If the contractual right argument was valid then this could elevate non GARs rights above those of the GARs. They would be entitled to asset share and would not have to prove financial loss as they would for mis-selling. It was also recognised that the rectification scheme could be under threat if [Counsel for Equitable’s] arguments were found to have merit.

FSA note that publication of the opinion is planned for later that day, ‘although the conclusion about the inability of challenging the [House of Lords’] decision had already been leaked and was in last weekend’s press’. FSA express concern about publishing the opinion before examining it more closely. On implications for the compromise scheme, FSA record:

It was unclear how the Society was going to handle this issue in relation to the 425 scheme. Although it did appear that further work was needed to assess both the basis of [the Society’s Counsel’s] arguments and what further work was needed. [Equitable’s Chief Executive] believed that the majority of policyholders wanted an end to litigation and for example funding test cases on this issue was not immediately an attractive option. There was also the importance of getting a scheme in place by February 2002. It was still unclear as to whether an extension of time for this would be granted by the Halifax. [The Chief Executive] estimated that the further work required in unravelling [Counsel’s] opinion would take at least two months. It was confirmed that the Halifax would be kept up to speed on this issue as Halifax had a right to be informed on matters affecting the 425 scheme.

On the impact of the opinion on Equitable’s financial position, FSA record:

It appeared that the potential balance sheet effect of any mis-selling had yet to be formally considered by the Society. Conceptually it might be possible to perceive that the transfer of value from one set of policyholders to another (non GARs to GARs) that occurred after the [House of Lords] could either be eliminated or mitigated by a reverse transfer of value. However, as far as balance sheet liabilities are concerned this could also be construed to be an additional liability. [FSA’s Director of Insurance] reminded the visitors of their obligations as Appointed Actuary and Chief Executive and said that they needed to consider whether or not it was necessary to put up a reserve for this amount. [Equitable’s Chief Executive] was reminded about the need to ensure that this potential issue was considered vis a vis Directors and Officers Insurance.

It was also noted that the requirement of Companies Act and [Insurance Companies Act] were different. The Companies Act accounts could, for example carry this potential liability off balance sheet as a contingent liability (although the accounting treatment in the [Companies Act] accounts would be subject to [Financial Reporting System 12] and relevant accounting standards). However, the more conservative valuation basis required by the [Insurance Companies Act] might require the additional reserve to be included in the Annual Return. A significant additional reserve would almost certainly lead to the Society not covering its [Required Minimum Margin]. The Appointed Actuary said that if required the Society could find the amount required in the worse case scenario (the £1.5bn) but this would mean that the Society would have to move entirely out of equities and into gilts. The 2000 Annual Return had yet to be submitted (due 30 June) and thought would need to be given as to how this potential liability should be treated.

FSA’s letter of 04/05/2001 which gave some feedback on the actuarial part of the compromise scheme is discussed. FSA note: ‘[Equitable’s Chief Executive] was concerned about our comments about why less value was being given to occupational pension holders than individual pension holders. [FSA’s Head of Life Insurance] thought that a lower uplift could be used to different groups of policyholder provided this was borne out by informed behaviour. [Equitable’s Chief Executive] agreed that further justification was required to explain why the GAR take up rate amongst occupational pension holders was so low and further work was being carried out in this area. This work would also examine whether behaviour was different according to the size of scheme and if necessary uplift rates could be subdivided between large and small schemes’.

Under ‘Action Points’, Equitable agree to let FSA know when they planned to publish their press notice on the opinion and to provide them with a copy prior to issue.

PIA thank FSA for the information provided on 03/05/2001 [16:39] about Equitable’s perception of risk linked to the court cases and potential mis-selling. PIA say that the material was confirmation of what Equitable thought. However, PIA ask FSA if they had any evidence as to why the Society had thought that way, specifically:

1)Why did Equitable think scenarios 5 and 6 (June 1999) were unlikely and “inconceivable”?

2)Why, on 18th July 2000, did Equitable still feel the eventual outcome was “unlikely”?

3)When did planning for the possibility of no purchaser being found start? It seems not until late [November] 2000 – do we have documentation explaining why there was no planning before this?

FSA’s Press Office inform the Director of GCD and other officials that Equitable were due to issue a press notice on Counsel’s opinion the following day, and planned to publish the opinion in full.

[15:41] The Director of Insurance says: ‘This is bad news – and disappointing given [the Chief Executive’s] clear recognition this morning that an early release of the whole opinion would create major difficulties for the company’. The Director notes that Line Manager E was preparing a question and answer briefing paper, but:

… there are particular areas of difficulty:

a)we will clearly not be in a position to cover the “misselling” issue in relation both to ELAS (and more particularly to other companies) in the context of a wider statement about [PIA’s] work (as [the Director of GCD] had suggested earlier this week) and we will need some sort of holding line;

b)we and the company will need to be ready to say something about solvency margin coverage/reserving implications if challenged. Ideally we will need to say things which are not inconsistent;

For the rest I imagine that both we and the company will wish to [emphasise] the extremely speculative nature of [Counsel’s] opinion on misselling/contractual warranties (there is a helpful piece in which he draws attention to the fact that he has done no more than identify a theoretical possibility; that substantial work would need to be done to ascertain whether there is any substance to it, and that no-one should rush to the view that it will be possible to establish offsetting rights that might “neutralise” the House of Lords judgement in whole or in part.

The Director of Insurance adds:

I imagine the company will need to concede that this may delay the presentation of

an outline of the s425 scheme, and the scheme itself. But they (and I think we) will need to stick to the line that such a scheme still offers the best way of achieving certainty and stability.

I guess the Halifax may be asked whether they would be prepared to extend their deadline. I imagine that they will be (at best) non-committal, and that we should not get drawn on this.

I will try to touch base with [Equitable’s Chief Executive] to discuss how they will be handling, particularly on the solvency margin issue.

[16:07] The Director of GCD warns that FSA needed to be cautious about describing

the opinion as ‘speculative’. He says: ‘The analysis of the [LAUTRO] rules is serious stuff, and does in my view raise real issues about whether compliant disclosure was made.

That does not mean that further work is not needed. But that should be our emphasis, rather than describing the paper as speculative, which we would later regret as too dismissive’.

[16:29] The Director of Insurance writes again, having spoken to Equitable’s Chief Executive, recording that:

He was apologetic that he had not carried the day on publication. However he felt that the revised press notice was “incomparably better” than the original version (which we had not seen).

He agreed that we should liaise over the lines we would each use with the press. He was considering what to say [about] two of the key issues – reserving and the future of the s425 scheme.

On reserving he thinks the [Equitable’s] line will be that the opinion changes nothing. The possibility of non-GAR policyholders having a right of action against the Society has been a matter of debate for some time. The Society are confident, on the basis of their current understanding of the position, that they continue to meet the statutory solvency margin requirements. Should the further work now put in hand on the non-GAR rights of a action issue put that position in doubt the Society have adequate room for manoeuvre to ensure that the statutory margins remain covered;.

On the s425 scheme the Society are likely to take the position that this remains the best way forward in the interests of all policyholders. They will express the hope, if asked, that this will not lead to a delay in their bringing forward proposals. (They had not planned to produce an outline plan before the AGM, only to comment on the progress being made, so that there is nothing that had been planned for the immediate future that will be put back).

Equitable send FSA a summary of their estimated solvency position at 31 March 2001, which showed:

Solvency position at 31 March 2001

Equitable say work was continuing on the production of an actuarial certificate in support of the implicit item and they would let FSA have that as soon as possible.

FSA meet to discuss Line Manager E’s note of 03/05/2001 about the reporting concessions sought by Equitable. FSA’s note of the meeting (which is not written up until 22 May 2001) records:

The meeting agreed that the concession relating to the valuation of Permanent Insurance was acceptable.

There was some discussion of the concession relating to fixed interest assets. It was noted in discussion that we had not objected to the method originally favoured by Equitable Life when the matter was first raised, and that we considered their approach to be preferable to that under the regulations (which we consider are defective). However, the approach was different from that adopted by certain other companies. The differences were thought to be justifiable because of the different types of business. Equitable Life has said it would move to the other basis for future years for consistency with the methodology used by others, but could not do so in relation to the 2000 year end. The FSA would be able to decide which would be the appropriate basis going forward, not the Society. It was also noted that [FSA] would be looking to amend the relevant part of the Integrated Prudential Sourcebook going forward and work on amending the defective regulations was already in hand.

It was understood that the Society would be solvent whether or not the concession were granted. However, without it, the position would be very tight and particularly with the [Counsel for Equitable’s] opinion could lead to concerns about the true solvency position. It was noted that while the concession of itself seemed innocuous, when considered alongside others such as the implicit item for future profits and the subordinated loan, for example, pointed to a tendency for Equitable Life to select the most favourable valuation method in every case. However, it was pointed out that the proposal for the concession arose as part of a review by GAD of the society’s reserving basis, with most of the improvements being adopted leading to an uplift in the reserving requirement, with a small number moving the other way. Overall, the Society was faced with an uplift in excess of £1 billion in its reserves. The issue had been live since November 2000 though it had taken some time before Equitable Life had been able to formalise its application.

The meeting considered that the basis on which the FSA was required to assess the application. [FSA’s Director of GCD] advised that the test under section 68 there was an open discretion but that was constrained by a requirement to act reasonably. He also noted that the decision was ultimately for the Treasury and that the FSA had to advise.

The meeting concluded... on balance it supported the application, largely on the basis there were no clear grounds for rejecting it. It was agreed that this should be made clear to the Treasury, along with the points about the impact and reasonableness of Equitable Life’s tendency to use the most favourable valuation basis to it.

FSA also discuss Counsel’s opinion and ‘It was agreed that the aim was to make as little comment as possible, noting that we would be looking at the opinion carefully, that it was only preliminary in its nature and noting that there was nothing new since we had already said publicly that we were considering some related issues on post court of appeal sales’.

[10:43] In response to this, the Head of Actuarial Support says:

Although we probably do not wish to mention it here, I believe that the Opinion would have much wider implications for insurers if it were accepted. In my view, it is not about GAR’s at all but about the question of inadequate representations being made to policyholders about how with-profit funds operate. In particular, it seems to be saying that policyholders were not made sufficiently aware that they would share in all trading profits and losses of the insurers and not just in the investment returns.

As such, this issue could affect all insurers that have written with-profit policies that envisage this wider participation in the profits (and losses) of the business. Of course, though, both the actual representations made to policyholders and the practice followed in the distribution of profits (including any contributions from or to the “estate”) will vary from company to company.

FSA’s supervisory file for Equitable contains a letter from PIA to the Society. The letter is in response to earlier correspondence from Equitable (dated 9 April 2001) about the approach they were taking to dealing with correspondence from policyholders about issues concerning the House of Lords’ ruling and Equitable’s subsequent closure to new business.

In that letter, Equitable explain that, due to ‘exceptional circumstances and levels of work being experienced’, they were not always answering each policyholder letter individually. Instead, Equitable were often answering queries about their corporate approach to these issues by mail shot. Equitable say that, given their approach, it was not possible to guarantee that all specific complaints of an individual nature, which might require investigation, were being answered. Equitable acknowledge, therefore, that there could be instances where they would not have complied with PIA rules on complaint handling.

PIA’s reply notes that this: ‘does not comply with PIA Rules and as such is unacceptable. However, given the “exceptional circumstances” that you indicate, PIA recognise that, for the immediate future, the most pragmatic approach is to carry on with the adopted process. However, I would request your urgent proposals for rectifying the position, including how you intend to address the potential for regulated complaints to be completely overlooked’.

FSA’s Chief Counsel B informs the Director of Insurance of the ‘preliminary observations’ of their Counsel on the opinion of Counsel that Equitable had received. The Chief Counsel says that Counsel had been unsurprised about what was said in the first part of the opinion on the possibility of reopening the House of Lords’ decision. Chief Counsel B goes on to record that Counsel:

… is, however, unnerved by the second part of the opinion which deals with possible liabilities which Equitable may have occurred in relation to the non-GAR policyholders. He is very concerned that the analysis is superficial and is without any proper or full analysis of what the implications are for Society and policyholders particularly as to how any such rights might be substantiated and its impact upon the process for reaching a compromise. To use his words, the Equitable must be mad if it is to publish the opinion as it stands on their website. He is concerned that the opinion will raise false hopes and or panic amongst policyholders and that it will, in the press and elsewhere, raise instant questions about the solvency of Equitable and conceivably precipitate events leading to a very early liquidation of the company.

Looking at the substance of some of [Counsel for Equitable’s] points, [Counsel] thinks that there is a very serious question to be addressed as to whether any of the regulatory rules, including those which on their face imposed strict obligations, have the effect contended for by [Counsel for Equitable]. One important issue is whether the disclosure requirements should be read as being subject to an implied term that the company’s duty to disclose extended only to those matters of which it had knowledge at the time or which, with reasonable diligence, it could have had knowledge. The analysis does not mention at all the significance of the guidance which had been issued to insurance companies (and later withdrawn) on the treatment of GAR policies in terms of bonus distribution. [Counsel for FSA] acknowledges that the Equitable’s duty of disclosure may well have changed with the onset of the Hyman litigation although further analysis will be needed to ascertain at what point the Equitable came under a duty to disclose the potential range of risks presented by the litigation and its various potential outcomes. [The FSA’s Counsel] took the point that the issues raised by [Counsel for Equitable] are ones which may also affect other companies which have issued GAR policies.

Chief Counsel B says that he would arrange for FSA to meet with Counsel the following day.

[12:30] The Director of Insurance welcomes the opportunity of a meeting, noting that: ‘As [the Head of Actuarial Support] has pointed out separately, this has potentially huge implications for the industry generally. If non disclosure of exposure to GAR liabilities amounts to any of the things [Counsel for Equitable] suggests then what about non (or non-effective) disclosure in with-profits business of exposure to mortality risk, business risk etc etc’. The Director also states that FSA had ‘discussed briefly whether we should go back to the Equitable to urge them again not to publish the full opinion. You said that [the Director of GCD] had discussed this with [FSA’s Chairman] who took the view that we had done all we could’.

FSA’s Director of GCD responds to the FSA official’s query of 09/05/2001 [11:31] with his ‘immediate comments’. The Director identifies two separate contexts in which the issue raised by Counsel could go to court. First, ‘as part of the s425 scheme, where the court would need to reach a view on the fairness of the scheme, having regard to the rights being given up’. Secondly, ‘as part of an independent attempt by Equitable to determine the extent of the rights, or by policyholders to enforce them’.

The Director of GCD says that his preference would be for the valuation of the claims as part of the compromise scheme. The Director says that he considered that Equitable should decide how they would want the scheme to take account of the value of the claims and obtain appropriate substantiation to demonstrate to FSA, policyholders and the court that it was a fair basis for a compromise.

[14:16] The FSA official says that this did not answer the question of whether there was any regulatory action that FSA could take that they should consider.

FSA write to Counsel ahead of a meeting planned for the following day.

[17:21] In response to receiving a copy of the letter, the Head of Actuarial Support says: ‘If the company end up having to submit a set of returns showing that they have insufficient assets to cover their liabilities, then HMT would seem to have the right to petition for a winding-up, and Section 54(3) of ICA 1982 says that we would then have sufficient evidence that they were unable to pay their debts. This would then seem to allow Section 58 to be applied, namely for a court to reduce the amount of the contracts on such terms and conditions as it considers just. I suppose this might be an alternative to the Section 425 scheme, though I am not sure exactly how it would work procedurally, or how it would be received by policyholders. Is this worth looking at with Counsel as well?’.

[17:54] The Director of Insurance replies: ‘I’m inclined to think that we need to do rather more analysis (policy as well as legal) before seeking counsel’s views. For the present I think we might better focus on the work that might be done to decide whether there is a reasonable likelihood that there might be valid claims, how these might be quantified (if this is necessary) and how this might be factored into a fair s425 scheme. I suspect that petitioning for winding up would still be contrary to policyholders interests, and not something that we should contemplate while the company is still solvent – even if it is below required margins of solvency. After all our natural first step if margins are uncovered is to require the submission of a plan. It would surely only be if the company could not put together a credible plan that we would contemplate a petition. And the company have at least two possible avenues if required to submit a plan: to promote a s425 scheme, and to rebalance their equity/fixed interest investments’.

FSA’s Director of GCD attends an Inner Temple guest night, during which he has a ‘fairly cautious on [his] part’ conversation with Counsel for Equitable about the opinion which had been provided. The Director’s note of the conversation (which he circulates on 15 May 2001) includes that:

• [Counsel] recognised that his Opinion was much more comprehensive and detailed on the inability to reopen the House of Lords case than it was on the possibility of parallel rights, but he did not see any particular difficulty with this, even though he recognised that it was the second part which would be seen as more significant;
• [Counsel] expected to be asked to advise further on the issue of collateral claims, and did not see anything odd in being asked to do so by the Equitable, notwithstanding that their own position might be prejudiced by his conclusions;
• [Counsel] expected that it would be a couple of months before he was able to complete his work on the second part;
• [Counsel] recognised that his conclusions would potentially lead to issues about the solvency of the company, and that it was not clear how the rights he had identified could be brought into account in the section 425 scheme, but thought these were points for others to address; [and]
• [Counsel] also recognised that his work here was likely to make him a focus for controversy, but had no difficulty with this’.

FSA hold a conference with their Counsel to consider the draft opinion of Counsel for Equitable. FSA record the headline points from the conference as being:

• he believed that [Counsel for Equitable] was wrong to say that the court had implied a term into the policies: rather they had done it into the articles;
• the significance of this was that it was, in his view, legally impossible for them to imply a contrary term into the policies, namely that GAR policyholders should be entitled to their asset share, less a limited range of specified expenses;
• this was because if there was an implied term in the articles, it covered everyone, both GAR and non GAR;
• it cannot be accepted that the court would imply two contradictory implied terms: the true implied term is a single one, that a discretion cannot be exercised to deprive people of their legal rights;
• [the FSA’s Counsel] was also unhappy with the implied assumption in the opinion that the court was requiring the company to act unfairly: this had been the Equitable’s traditional view, but the true position  was that the premise from which the court would decide fairness was the contractual obligations of the parties;
• the contractual rights of parties was also the proper foundation for policyholders reasonable expectations;
• [Counsel for FSA] noted that the [Society’s Counsel’s] Opinion seemed to be premised on the idea that a non GAR policyholder was entitled to his smoothed asset share less expenses and that anything which might deprive him of this ought to be disclosed, but it was noted that all that non GAR policyholders were entitled to was a smoothed return, “reflecting asset share”;
• there was a parallel issue raised by the instructions about what access policyholders had to information about their rights;
• his view was that, in a mutual, you must be taken to know that all other members have rights, and that the society must comply with all of them;
• he was much less sceptical about whether there had been a material non disclosure, but noted that this would only lead to tort damages, not contract damages;
• there was an important point on burden of proof according to whether this was common law negligence, or negligent misrepresentation under the misrepresentation act: in the latter case, it was for the misrepresentor to show the innocence of the misrepresentation;
• there was an assumption in the [Counsel for Equitable’s] Opinion that if the risks had been properly disclosed, the policies were unmarketable, but he doubted whether this was the case;
• we asked him to consider whether the classification of rights as between contract and tort made any difference to the way in which they would be treated in the section 425 scheme: his initial view was that, if these were not rights of members which were compromisable in that way, they were rights of creditors which could be compromised as such; [and]
• overall, his view was that courts below the House of Lords would be very wary of seeking to neutralise the position taken by that court’.

FSA agree that they should alert Equitable to the fundamental concerns which FSA’s Counsel had expressed about the opinion provided by Counsel to Equitable.

Following the conference with Counsel, FSA telephone Equitable to discuss publication of their Counsel’s opinion. Equitable tell FSA that Halifax had objected to publication on the grounds that the agreements between the two companies provided for consultation before any action was taken which might affect the possibility of achieving the policyholder compromise. FSA inform Equitable of the advice that FSA had received that morning and FSA raise concerns about Equitable going ahead with publication. Equitable say that it would be inappropriate for them to proceed to publication without having considered the views of Counsel for FSA and agree to give FSA advance warning before publication, whenever that were to happen.

The Director of Insurance distributes his note of the telephone call, along with a draft letter to Equitable, prepared with Counsel that morning, setting out their concerns.

[15:13] The Director of GCD informs the Director of Insurance that FSA’s Chairman, having made some changes, agrees with the letter to be sent.

[15:34] FSA write to Equitable. FSA say that they did not disagree with the conclusions in relation to the first part of the opinion. However, FSA write:

We are concerned that the second part of the Opinion, which is in terms much more tentative, might nonetheless risk misleading both non-GAR and GAR policyholders as to the scope for non-GAR policyholders making claims against the Society. This might in turn lead to such policyholders making investment decisions on a false, or at least doubtful, basis.

In particular, on the basis of our lawyers advice, we have considerable difficulty

with [Counsel’s] conclusion that “there are arguments that the non-GAR policyholders have contractual rights to share in profits without the GARs being taken into account” …

One premise on which this part of the Opinion appears to be based is that the House of Lords decided that the terms that the article 65 discretion would not be used to undermine the right of policyholders was a term implied in the GAR policies … As is recognised … this is not the case, The term is to be implied in the Articles themselves.

Given that all policyholders are subject to the Articles, it seems to us highly improbable that the courts would find there to be any contractual provision inconsistent with, or that would neutralise the effect of, that implied term, whether by way of implied term in the non-GAR policies or by way of implied collateral warranty.

Secondly, another premise on which this part of the Opinion appears to rest is that the House of Lords have required the Society to act “unfairly” towards non-GAR policyholders … We would be surprised if the courts would take the view that to give effect to policyholders contractual rights could properly be described as unfair. We are therefore concerned that a significant part of [Counsel’s] Opinion may be based on an assumption that is questionable.

For the avoidance of doubt, I should make clear that we regard the matters raised by the Opinion as very weighty. Even if the particular issues in this letter can be resolved, we would need to term our own views on the approach canvassed by the second part of the Opinion as a whole.

FSA say that they would be happy for both Counsels to meet to discuss this.

[15:44] FSA forward a copy of the letter to Counsel saying that Counsel for Equitable might be in touch later that day.

FSA’s Chairman, Director of Insurance and Director of GCD meet to consider how to respond to the prospect of Equitable publishing Counsel’s opinion. FSA record:

In particular, consideration was given to whether the situation would justify the exercise of statutory powers to require them not to put the Opinion on to their website (or otherwise make it public) in its current form.

The statutory power was exercisable for the purpose of ensuring that a company conducts its business in a sound and prudent manner and that a company would not be regarded as conducting business in a sound and prudent manner if it failed to conduct its business with due regard to the interests of policyholders.

It was noted that:

• the company had committed to publishing the Opinion, and had obtained views from leading and junior counsel;
• our concerns about the soundness of the Opinion had been made clear to the Company’s counsel, who had an opportunity to revise their views;
• the relevant part of the Opinion was expressed to be preliminary and tentative, and there was material emphasising this in the Equitable’s draft press release;
• if it was concluded that this preliminary and tentative Opinion gave a misleading impression, further clarity could be given through the further advice being sought from [the Society’s Counsel], or if necessary by a statement of our own views on the position;
• our consistent approach to the use of these legal powers was that they should be used to deal with serious concerns about a company’s conduct of its affairs, but not to allow the regulator to micromanage those affairs.

In these circumstances, it was concluded that it was not appropriate to prevent the Equitable publishing the Opinion in its current form.

However, it was noted that the circumstances did give [rise] to concern on sound and prudent management grounds since:

• the Opinion dealt with issues of great significance for policyholders but was being published at a point when little reliance could be placed on its very tentative conclusions, and without, it seemed, readiness to postpone publication even for the short period necessary to allow Counsel for the Equitable and the FSA to consider the matter together over the weekend: (in the event, such discussions did take place because of a postponement to the publication timetable following an intervention by the Halifax);
• in the course of the discussions it had become apparent that this was being done notwithstanding the serious doubts of the company’s chief executive;
• there was also concern that the Halifax had not been properly consulted about the publication, and that there was a lack of goodwill and mutual trust between the Halifax and the management of the Equitable.

There were issues which would need to be closely monitored.

FSA’s Director of GCD advises the Head of Life Insurance that he believed FSA should not take part in any discussions between Equitable and Halifax in relation to the publication of Counsel’s opinion. The Director of GCD does, however, advise that FSA should use this opportunity to reinforce their concerns with Equitable. The Director suggests that FSA should write to Equitable:

… indicating that we would find it helpful if:

• we could understand what their position is on the issues raised by the [Society’s Counsel’s] opinion;
• we could also understand how they proposed to deal with those issues, in the context of the planned 425 scheme, for example, whether they wished to have them resolved by separate court action, in advance of the 425 scheme; and
• what they can do to explain publicly when they publish the [Counsel for Equitable’s] opinion how the issues raised by the Opinion will be dealt with in the context of the s425 scheme.

FSA write to Equitable about Counsel’s opinion. FSA ask three questions on issues which they would find it helpful to have a clearer understanding of how Equitable proposed to proceed (in line with the Director of GCD’s suggestion that morning).

FSA write again to Equitable to request the bundle of factual material supplied to Counsel.

FSA’s Director of GCD writes to the Head of Life Insurance further to their conference with Counsel (see 11/05/2001 [11:00]), at which it had been said that Equitable were now attempting to take the view that the House of Lords’ decision did not prevent the declaration of differential bonuses from year to year.

[12:33] The Head of Life Insurance asks supervisors to report any cases of companies attempting to neutralise the effect of annuity guarantees, clarifying that: ‘The idea is that all policies issued in a given year could form a distinct category for bonus purposes. This is an idea of [Equitable’s Chief Executive’s], and I know of no evidence that it is more widely held’.

FSA hold an Equitable Life Lawyers Group meeting. The issues discussed by the Group include:

Compensation

Chief Counsel B informs the Group that, in a meeting with FSA on 10 May 2001, Equitable had ‘referred to Article 4 as enabling the capping of liabilities’. Chief Counsel B expresses concern that the capping of liabilities had been emphasised rather than mutuality and the Group note that Equitable’s comments had been made, despite the fact that their Counsel did not support that view.

The Group discuss the possibility of common law claims and whether these would be covered by Article 4 and ‘It was concluded that such claims would probably be met before payments were made under Article 4’.

Market value adjuster

Chief Counsel B states that he had concerns in relation to the implications of Counsel for Equitable’s opinion ‘for the whole matter of the use of MVAs’. The Group note that FSA had taken ‘custody’ of the OFT work, although they were awaiting a note from the Head of Consumer Protection on this. It is agreed that FSA should seek the views of Counsel on this.

‘Legal action against FSA’

Under the heading ‘Legal action against FSA’, the minutes record: ‘[An FSA legal adviser] advised the group that the 1st Life Directive imposed a duty on Member States to ensure that firms established adequate technical provisions. [The adviser] agreed to prepare a note on the implications of this provision and the nature of any consequential duties imposed upon a Member State’.

The Group’s ‘legal issues’ list is updated the following day and, under ‘Issues arising from the Opinion of [the Society’s Counsel]’, the following is included:

(a) Impact of section 425 compromise.

(b) Effect on IC Act reserving requirements.

(c) Companies Act solvency issues.

(d) Whether the opinion should be published.

(e) FSA response to the opinion.

FSA’s Chief Counsel B seeks an update from the Head of Consumer Protection on the work that was being transferred from the OFT.

[17:57] The Department reports that the cases had not yet been received from the OFT.

Equitable send FSA a copy of the press notice to be issued at 16:30 that day about Counsel’s opinion.

[16:34] Equitable’s advisers also send FSA a copy of their question and answer briefing.

[17:49] Equitable also send FSA a copy of Counsel’s opinion.

FSA send HMT their recommendations that Equitable should be granted section 68 Orders for the value of Permanent Insurance and for the calculation of the rates of interest for fixed interest assets. FSA say that ‘the valuation of Permanent [Insurance] is quite straight forward’. FSA continue, saying:

The concession relating to rates of interest is more complex. We can provide a more detailed technical explanation if that would help. However, there are two further helpful points I can probably make. First, the concession was originally requested last November, at a time when the FSA, with GAD, had been carefully scrutinising the last returns. The examination identified a number of issues which have led to a modification of the valuation basis used, which overall leads to an increase in the reserving requirement. Second, you will also wish to be aware that because of the defects in Regulation 69, we are proposing that going forward, we should produce a requirement for firms generally to calculate the relevant rates of interest along the lines of [one of] the methodologies described in the paper.

I think it is important to remind you that a number of concessions have been granted to Equitable Life. Some have been fairly routine, such as the increase on the admissibility limits on certain shareholdings, including most notably those in [a named company] following its merger last December. There are of course some others, including the order permitting Equitable to include among its assets an implicit item for future profits and that allowing it to count the subordinated loan. Inevitably, as concessions are disclosed in the annual returns, some commentators will suggest that while individually the concessions may seem reasonable, that collectively it could be argued that the Society has been permitted to elect the most favourable valuation basis on each occasion. Our view is that such criticism would be unfair because we have worked hard with the company to improve the reliability of its financial reporting; and the effect has sometimes been to increase the level of reserves required.

FSA enclose a note on the two concessions, along with the papers that had been submitted to their Insurance Supervisory Committee and draft Orders to be sent to Equitable, if it were agreed that their applications should be granted.

FSA’s actuarial department provide PIA with advice on the performance of closed with-profit funds, in response to their request of 11/05/2001 [15:30]. FSA explain that: ‘Closure of a with-profit fund could significantly impact on several factors that affect the level and volatility of maturity payouts. The most important impact is on future investment performance and bonus strategy. Closure can also affect staffing, expense levels and distribution of the estate’.

One of the points stated is that: ‘The initial loss of new business strain may result in a closed fund enjoying improved statutory solvency for the period soon after closure, although this may be partially offset by having to pay closure costs’.

In conclusion, FSA say:

… it would be fair to say that for weak funds (such as the Equitable’s after the House of Lords decision) closing to new business is unlikely to result in a lower level of payouts than remaining open. Payouts may even be higher. This is largely because weak funds would find that staying open to new business would severely affect their investment freedom.

Thus, the fact that policyholders have bought into a fund that subsequently closed would probably not have affected their expected payouts much per se. More importantly is the fact that they bought into a fund that had a weak underlying financial position.

Closure would also affect the pattern of payouts – possibly with more volatile payouts with higher terminal bonus content. The effect of payouts may be different for policies with different terms to maturity.

FSA’s Director of GCD informs the Head of Life Insurance of a conversation with Counsel the previous night, who had then read the final version of Counsel for Equitable’s opinion. The Director says that Counsel ‘was even more strongly of the opinion than before that it was wrong, and concerned about the society’s conduct in publishing it’. He also reports that Counsel had identified two issues, being:

The first was the oddity, as he saw it, of the Society effectively taking sides with the non GAR against the GAR policyholders in trying to neutralise the court decision. This seemed to him to reflect an ongoing unwillingness on the part of the company to accept the court decision. In his view, if the reality was that [Counsel for Equitable] had been asked to look after the interests of the non GAR, we should consider requiring the society to instruct someone to look after the interests of the GAR policyholders. Otherwise, the society’s funds were being used to support the claims of one group of its members against those of another.

The second issue was that he thought that close readers of paragraph 97 of the Opinion will detect in the reference there to resolving the dispute with a view to paying a dividend [for] the risk that the company might become insolvent. This suggests that GAR policyholders might wish to bail out.

[17:21] The Head of Life Insurance says that FSA would pursue these points with Equitable at the meeting arranged for 21/05/2001.

An FSA Board member and Chairman of FSA’s Pension Plan Trustee Limited informs Managing Director A and FSA’s Chairman that the trustees of the scheme intended to cast their vote on the election of Equitable directors. The member says that neither they nor FSA’s Company Secretary had taken any part in the discussion.

It was subsequently agreed that FSA should ask their pension scheme to confirm that they had reached their conclusions without input from any Board member or anyone involved in the supervision of Equitable, so as to close off one possible source of criticism.

FSA’s Director of GCD writes further to his earlier advice to an official (see 10/05/2001 [14:14]), expanding upon the regulatory action FSA could take in this area. The Director says that he thought that FSA’s existing strategy ‘goes some considerable way in this respect’, which was to:

• seek advice from [Counsel] on the extent of a firm’s duties to make disclosures which would be relevant in these circumstances;
• with a view to possible publication either of his Opinion, or of an FSA document based on it; and
• consideration, on the back of that, and the [FSA] misselling review, as to whether, either at the Equitable or other companies, there is a need for a targeted endowment style review to ensure that redress is paid where due’.

FSA’s Chief Counsel B prepares a statement for possible issue about FSA’s progress on their review of mis-selling by Equitable. The statement includes the following ‘broad conclusions’ of the factual ‘Stage 1’ PIA report:

• The Equitable did not identify a need to disclose directly to potential purchasers any specific risks associated with the outcome of the litigation.
• The Equitable sales literature and written disclosures did not change materially during this period.
• The potential uncertainties surrounding the sales process were not mentioned during the period after the company had put itself up for sale.
• When responding to those few complaints about misselling which were made during this period, the Equitable stated that its communications with consumers had been based upon its best understanding of the position at the time.

[18:33] The Head of Life Insurance suggests that issuing such a statement was ‘Difficult territory’.

FSA’s Head of Actuarial Support asks Scrutinising Actuary F, in response to the Chairman’s request of 17/05/2001 [08:58], to look back through their files for information about how the market value adjuster had been assessed. The Head of Actuarial Support comments: ‘I think [Equitable] said at one point that in theory it should be around 12.5%’.

[10:55] Scrutinising Actuary F explains to the Head of Actuarial Support and the Head of Life Insurance that Equitable had applied a market value adjuster since the House of Lords’ ruling in July 2000 and that it had been initially set at 5%, increasing to 10% when they closed to new business on 08/12/2000 and then to 15% on 16/03/2001. The Scrutinising Actuary goes on to say:

In a note dated 19.12.00, [Equitable] set out the rationale behind the application of the MVA, and its amount. He said that the level of 10% corresponded to a FTSE level of around 6300. There are three components of the MVA, of which investment market levels was the main factor. (The other factors were an adjustment to recoup the balance of initial expenses still outstanding, and a further adjustment to “protect the future solvency and investment freedom of the fund”). Of the 10% MVA, 7.5% related to the level of the markets.

In the same note of 19.12.00, [Equitable] said that should the market fall to 6100, and stay there, a move in the MVA to 12.5% would be appropriate. (Of this, 10% would be the “investment related” part.)

In an update from the Society dated 13.03.2001, they said that the theoretical levels of the investment related part of the MVA were 10% at 6100, increasing to 13% at 5700. (A further 2% on top is required in respect of recouping initial expenses.)

At 13.03.01, when I believe the Society took the decision to increase the MVA to 15% (this was implemented on 16.03), the FTSE closed at 5720.

If the market were now to stabilise at a FTSE level of around 5900, then the “theoretically correct” MVA would be 11.5% plus 2% expense adjustment = 13.5%.

Whether the Society have any plans to reduce the MVA is a topic which I suggest is discussed with them at the next meeting on 21st May.

[11:05] The Head of Life Insurance forwards the note to FSA’s Chairman.

[12:38] The Chairman comments: ‘I don’t think we need be pressing them to make an adjustment if the theoretically correct level is 13.5[%]. They’ve set some kind of precedent by moving in 5s, and I guess there’s a greater risk of major outflows at 10[%] if they’ve once been to 15[%]’.

FSA meet Equitable to get an update on preparation for their annual general meeting, to take place on 23/05/2001, and on the compromise scheme. FSA’s note of the meeting records the discussion under the following headings.

Annual general meeting

Equitable explain the planned agenda for the meeting, which would include ‘an outline, without much content, of the way forward through the 425 scheme’. FSA note that the Chief Executive appeared slightly more comfortable about the vote for directors ‘mainly because the action groups had diluted their campaign by submitting so many candidates’. Equitable say that the results of their survey of policyholders’ views on a compromise would be released at the meeting and they indicate to FSA that it would show there was an ‘overwhelming consensus for a compromise [but] when it came down to sorting out the nature of an acceptable deal this consensus disappeared’. Equitable agree that FSA could send an observer to the meeting.

Counsel for Equitable’s opinion and the compromise scheme

Equitable say that Counsel needed to do further work on the rights of non-GAR policyholders and this would take a couple of months to complete. It was noted that a decision would need to be taken as to whether to include mis-selling claims in the compromise scheme and that this would be more likely if it were thought that any such liabilities were significant.

Equitable explain that ‘generic mis-selling cases had been rejected by the Society and parked by the PIA Ombudsman pending FSA’s exercise to examine generic mis-selling issues’.

2000 annual return

FSA record that:

[Equitable’s Chief Executive] and [Appointed Actuary] had given further thought to [Counsel’s opinion] and did not believe that a provision for mis-selling was necessary for the year 2000 Annual Returns. [The Chief Executive] said that the 2000 Report and Accounts already referred to fundamental uncertainty which covered the potential legal risks and they were considering what equivalent provision was needed in the Returns.

[The Appointed Actuary] suggested that they would look to see how much reserves could be released if they switched all their equities into [fixed interest securities] (which might indicate the maximum level of claim that could be sustained without them becoming insolvent).

FSA confirm that they had recommended to HMT that the requested section 68 Orders should be granted, ‘but this did not guarantee that they would be issued’.

Market value adjuster

Equitable explain that the: ‘estimate of the “realistic aggregate” MVA was a continually moving target and depended on market movements … As things stood at FTSE c5900 [Equitable’s Chief Executive] thought an MVA of 15% was quite justifiable’. Equitable say that, if the FTSE 100 Index settled at a level of around 6400, then they ‘might need to consider dropping back to 10%’.

Under ‘Action Points’, Equitable agree to:

• produce the next set of actuarial papers on the compromise scheme by the end of May; and
• ask their solicitors to send the draft legal section of the compromise scheme to FSA.

FSA agree to:

• forward further feedback on the actuarial paper for the compromise scheme; and
• inform the Irish and German regulators about the compromise proposals.

HMT reply to FSA’s letter of 14/05/2001 about Equitable’s applications for section 68 Orders. HMT say that the Order in relation to the valuation of Permanent Insurance is ‘non-controversial’. However, HMT say that the Order in relation to the valuation rates of interest ‘raises a few more questions’. HMT say that their:

… concerns centre on consistency and presentation. The [Insurance Supervisory Committee] paper you sent me says that you have made it clear to the Equitable “that a request for a concession would only be considered if the company would also use that valuation basis in future years, when it produced a less favourable result.” Elsewhere you make the point that you “look to companies to maintain consistency of valuation methods from one year to the next.” However, I understand that the Equitable has not used this concession before and is unlikely to be using it next year, since you will be reviewing the effects of Regulation 69 in general and will be developing a new methodology. So the Equitable will in fact use three different ways of calculating the valuation rate of interest in three years.

HMT note that there were several ways in which they might seek to defend the Order, although:

The argument that this is a method which in future years might result in a less favourable result for the Equitable is weakened if the concession is only for one year and will be changed to a different basis for the 2001 return…

The argument that it is the same as concessions given to other insurers also falls if it is in fact different from the methods used by [the two insurance companies]. Even if Equitable could conform to the same method of calculation, as they propose to do for future years, you make the point that the nature of these companies’ business is different from Equitable’s and more thought would be needed as to whether that approach was appropriate.

HMT continue:

It is therefore not clear whether it would be better to refuse the concession to preserve consistency of valuation with past years, or to grant the concession to ease the pressure on the fund of confirming with the reserving requirements. What makes this particularly difficult of course is the perception that it was a lack of adequate reserves which contributed to the Equitable’s closure to new business.

HMT suggest:

Might it not be preferable to develop the correct long-term approach first, and to change to it in 2001, instead of making a one-off concession this year that will then have to be changed in 2001 to a basis that can be sustained in the future?

HMT also note that:

Equitable estimated that not having this concession last year meant that their reserve was inflated by around £300 million. The estimate for the effect of the concession this year is of the order of £150-£200 million. How does this compare to the total value of reserves that they are required to hold?

HMT say that, given the sensitivities surrounding Equitable, they would want to ‘inform Ministers that officials are granting these concessions’. HMT ask for answers to their questions and details of the timetable that FSA were working to.

FSA’s Scrutinising Actuary F provides the Head of Life Insurance with an update to his note of 18/05/2001 [10:55] about the market value adjuster applied by Equitable. He says:

At yesterday’s meeting Equitable pointed out that the FTSE would need to move up to around 6400 before a reduction in the MVA to 10% could be justified. This contrasts with [Equitable] saying back in December that a 10% MVA corresponded to a FTSE level of 6300. As they explained yesterday, this is because they have been adding interim bonus at the rate of 8% p.a. to policy values, and this requires an element of capital appreciation as well as investment income to support it. In other words, if markets stand still, then policy values – as measured by “smoothed asset shares” – get even further ahead of the value of the underlying investments, and a greater MVA is needed to compensate.

They also reiterated that the MVA is doing no more than ensuring that outgoing policyholders take no more than their fair share of the fund on a non-contractual exit. (The fact remains that those taking contractual benefits – where no MVA applies – are getting more than their share of the cake. This is the concern I raised with them in an earlier meeting, which they conceded was true, but they reckoned they could live with so long as contractual termination rates did not increase unduly from current levels.)

Equitable send FSA a copy of the terms of reference for the Independent Actuary in relation to the compromise scheme.

[12:37] Line Manager E distributes the terms of reference, noting that FSA had decided not to approve them but had proposed to raise any concerns with Equitable.

[12:55] The Head of Actuarial Support says that he thought the terms of reference were reasonable but notes that they did not cover the fairness within each policyholder class, ‘particularly where there may be a separate offer made to different sub-classes within each class’.

PIA send FSA a copy of their comments on their draft ‘Stage 2’ report.

[14:53] FSA (Head of Actuarial Support) provide some immediate comments on the points raised by PIA which included:

1) In response to a comment that ‘Equitable was clearly weak and it knew it. This needs to be stressed’, FSA reply:

I am not at all sure that Equitable would have agreed that they were “weak”. They took the view throughout that they were meeting all the requirements of the solvency regulations, and indeed that the thinness of their cover for the margin of solvency was a result of the conservativeness of the regulations rather than a reflection of their true strength. We also know that they persuaded [Standard & Poor’s] until comparatively recently that they merited a AA rating.

2) In response to the comment that ‘the aim of [a with-profits policy] is to deliver asset share …’, it is said that that: ‘needs explaining. A minimum expectation for investing in a with-profits policy should be that you can expect a return of premiums less expenses accumulated at the underlying asset performance. Thus getting less than this as a result of financing the GAR of others would not satisfy this. It should not consist of [knowingly] contributing to the “operating fortunes” of others’. FSA reply:

I am not sure why there should be a minimum expectation that a policyholder would receive “asset share”. Surely this depends on how this has been presented to policyholders. For example, if they have been told that they will also share in the operating profits or losses of the business, then they might well receive less than these basic asset shares (which would of course need to be defined in any event). This is of course likely to be one of the key issues here, namely whether this sharing in the operating profits and losses was explained sufficiently clearly to potential Equitable policyholders.

3) In response to the comment that ‘Equitable was right to regard the likelihood of not finding a suitable purchaser as unlikely’, it is said that: ‘I would severely question this. The problem with the Equitable is that they had an arrogant view of their worth. They alone knew the true state. It was this state that shied off prospective purchasers’. FSA reply:

There is still much debate over the exact reasons why potential purchasers declined to become involved with Equitable. In my view, the only “asset” of real potential interest which they had to sell was the “goodwill” of the business. In view of the state of dissatisfaction among members that had been reached following the [House of Lords’] judgment, there were I believe significant misgivings among the bidders about the value of this “goodwill”, though Equitable did eventually reach an agreement with Halifax. In addition, the fund had been destabilised by the judgment as both the balance sheet position and potential bonuses had become much more sensitive to changes in market fixed-interest yields. There was also the difficulty that the perception by many members, of the Equitable’s worth to a purchaser, was probably too high.

4) In response to the comment that ‘with no purchaser it might be forced to close to new business’, it is noted that PIA’s:

… contention [is] that they should have been aware that the only justification of continuing to write new business was that there would be a purchaser and that without one closure was inevitable. There were thus three options:

1) close pending a purchaser

2) keep open on the assumption of a purchaser, but keep silent of the risk

3) keep open on the assumption of a purchaser but enclose a statement setting out the position,

FSA reply: ‘The Equitable was still just covering its margin of solvency following the [House of Lords’] judgment. However, the actuary had recognised that they were then unacceptably weak to continue as an ongoing operation. Accordingly, they sought a purchaser for the business. After failing to find a purchaser, they recognised that they had no realistic alternative but to close to new business’.

5) In response to the comment that ‘Equitable’s analysis that it was likely to find a purchaser on the terms that it sought was reasonable’, it is said that: ‘I am far from convinced that this was the case. What exactly do we know about the analysis? They had concluded that there was a very large hole. We must give evidence of why FSA believes this’. FSA reply: ‘I don’t know where this suggestion of a “very large hole” is coming from. Potential purchasers were given a detailed report by [auditors from the same firm as Equitable’s auditors] … on the prospects for the business. In addition, we know that their end-2000 report has now been signed off, with reference only to two areas of fundamental uncertainty, namely (a) the effect of the [House of Lords] judgment (on for example the propensity of GAR policyholders to pay additional premiums) and (b) the risk of further legal cases (eg in relation to mis-selling to Non-GAR policyholders)’.

[15:35] The PIA official clarifies that he was talking in general terms but on the specific points, using the numbering above, he says that:

1) ‘… my “weak” was referring to its position in attracting a bid. The strengths included the salesforce and its administration systems. Its main weakness were concerns about the state of the existing portfolio of policies. The fact that a [House of Lords’] ruling was immediately followed by putting up for sale meant that there was a real weakness in the perception of the Equitable’s portfolio of policies.’

2) ‘An investor who enters a with-profits or mutual fund knows that they are subject to profits and losses but it is very difficult to justify buying a policy if a proportion of one’s premiums are going to finance an existing known source of loss. Hence my view that there should be a minimum expectation as stated (without a bias towards financing losses).’

3) ‘… you state “unacceptably weak to continue as an ongoing operation.” Closure meant that future potential customers avoid that weakness but while it was on offer, customers entered the fund.’

4) ‘“hole” may not be the precise word but there was a very large problem which, I assume, they wanted solved by a purchaser putting money into the company. When this failed they closed.’

PIA conclude by saying: ‘The fact remains that they did not attract a bidder. Why was this given the level of interest? Either there was not enough value or something frightened them. The relevant point is “How confident should the Equitable have been when they put themselves up for sale?” I am an outsider to this issue as I have no detailed knowledge of the state of the Equitable but I still, on reflection, state that I cannot recall another case with as high a risk as the Equitable. If anyone can hint a name, I would be pleased to know’.

[16:12] FSA’s Head of Actuarial Support concludes the exchange by saying, in relation to point 2) that:

I would say that [Equitable] introduced the cut in the first 7 months bonuses in 2000 so that new policyholders after the [House of Lords’] judgment would not be expected to contribute to the expected loss though they would of course participate in any profits or losses that might arise if the actual experience turned out differently.

Before the [House of Lords’] judgment, they would no doubt say that they had no reason to believe that the non-GAR policies would be expected to incur significant profits or losses in respect of the GAR experience, and in particular there was not the expected loss of £1.5 billion that arose following that judgment.

I should add of course that the above figure, and others in the note, relate of course to the financial position as shown in the company accounts rather than the FSA returns.

FSA’s Head of Life Insurance sends FSA’s Chairman a copy of Scrutinising Actuary F’s further note on the market value adjuster applied by Equitable (see 22/05/2001 [10:35]).

[10:47] In reply, the Chairman says: ‘I do not recall them making the point about interim bonuses when they last moved the mva. I think they will have great difficultly explaining why they don’t move down, if the market gets back to the point it was at before they changed. I’m afraid this is yet another example of their lack of candour’.

[11:31] The Head of Actuarial Support comments:

A key problem at the moment for them is how to generate some realistic expectations about the levels of bonus and MVA that the fund can afford. In the last few years, they have been content to pay out higher levels of bonus than have been earned by the fund as part of their smoothing of investment returns. In addition, they paid out full policy values without any MVA to surrendering policyholders even when their actual assets were less than the aggregate of all these policy values.

For example, they are currently increasing the policy values (on which both the retirement benefits and also the discretionary surrender values are based) by 8% per annum. This rate of increase is well in excess of the investment returns that they have earned since end-2000 or indeed during the year 2000 as well.

Accordingly, they are incurring financial strains at present whenever benefits are taken on retirement. In addition, they believe that they have to set the MVA at 15% so that the departing policyholders do not take more than their fair share of the actual assets held by the Society.

The reality therefore is that at present market levels they need to find some way of reducing this rate of interim bonus if they are to restore some measure of stability to the fund, and also to have a reasonable chance of reducing the MVA on surrender.

If the market does manage to return to end-99 levels, then they may be able to rationalise this interim bonus rate in terms of their actual investment returns, and could even come under pressure to increase it. However, they would then still need to maintain a significant MVA to protect the fund against surrenders. They are caught therefore in [public relations] terms between a rock and a hard place unless they can find some way of generating more realistic expectations of what the fund can afford.

FSA’s Director of GCD writes to the Chairman and the Head of Actuarial Support saying that he agreed that the notes of 17/05/2001 [08:58], 18/05/2001 [10:55], 22/05/2001 [10:35] and 23/05/2001 [11:31] on the market value adjuster applied by Equitable raised serious concerns. The Director of GCD says:

The first is about PRE. Don’t we need to consider whether, by meeting the unreasonable expectations of some policyholders they are depriving other policyholders of their reasonable ones? Is this a decision which has been taken by the Equitable at Board level?

The second is about exposure to risk. [Scrutinising Actuary F] reports the [Equitable] as saying that they can live with people taking contractual benefits so long as contractual termination rates do not rise significantly. But what if they do? Is the suggestion that they would then introduce an MVA on contractual termination? But we have not seen an analysis which suggests that they are entitled to do so.

The third is about the compromise. Has [Counsel for Equitable] been asked specifically to advise on how any liabilities should be brought into account in the compromise? Is he instructed for the Equitable on the compromise?

[20:11] Chief Counsel A suggests that the Head of Life Insurance should reply in the first instance to the points raised in the first two paragraphs above.

PIA chase comments on their draft ‘Stage 2’ report. PIA suggest getting together for a meeting to discuss.

FSA send PIA a note of their comments, which included the following:

• On the statement that PIA ‘has established the following specific key risks Equitable did not disclose to clients’, FSA question whether ‘we’ are only concerned about new policyholders and they ask ‘What about people deciding whether to pay additional premiums? Or people who with “adequate” disclosure might have decided to quit the w/p fund while they were ahead?’.
• In response to a request within the draft report that FSA should provide details of where potential investors could find information on the financial strength of companies, FSA say: ‘The key first hand data will [be] the company’s annual report and accounts, the statutory returns and any formal statements issued … In addition, data is available from the rating agencies, which may or may not be based on access to privileged information, and commentaries in the business and trade press (eg Money Management, [the Financial Times])’.
• In response to point 3) of PIA’s comments of 23/05/2001 [08:59], about whether Equitable had been right to think that not finding a purchaser was unlikely, FSA say that ‘… it rather seems to assume that the reason why the sale was not successful was the GAR exposure, but it is far from clear that that was the [main/only] reason. Neither of the two most persistent bidders specifically gave that as one of their reasons for dropping out (although it was clearly a factor in determining the amount they would offer if they went ahead)’. FSA also state, in response to point 4) of the comments above, that:

… it was likely that the fund would be closed whether a buyer was found or not. The distinction between the outcomes was therefore likely to be about the need to change investment strategy and the likely level of capital support available.

FSA’s Line Manager E informs Equitable supervisors that the details of Equitable’s policyholder survey were now on their website. The Line Manager comments:

Some of the findings are very predictable – younger GAR policyholders do not think that their older colleagues should get paid more; older GAR policyholders think they should. But there are also encouraging signs, such as 91% believe a compromise is important, compared with 3% who do not.

It is also quite interesting to see the responses to questions such as how concerned are you – on a scale of 1 to 10 [highest] – about the safety of your savings, where it produces a graph something like a cross section of the Alps rather than an exponential curve (rising on the side of very) that you might expect. 10 was the most popular response numerically, followed by 5, 8 then 1.

The results for all policyholder types to this question were as follows:

FSA’s Director of GCD asks Legal Adviser D to clarify what constitutes a liability under a section 425 compromise scheme, explaining:

What I have in mind is the distinction that is sometimes drawn between the contractual or guaranteed liabilities of a company to its policyholders, and supposedly non contractual liabilities such as rights to a terminal bonus of a particular amount, or calculated on a particular basis.

Am I right to think that this, and perhaps other expectations, do not constitute liabilities which would be brought into account into a section 425 scheme? If they are outside such a scheme, what is their status following the agreement of such a scheme?

The Economic Secretary to the Treasury, having seen the note on Equitable’s applications for the section 68 Orders of 24/05/2001 [11:21], asks whether the official was seeking Ministerial approval for the Orders. The Economic Secretary says that, if the official was, then she would need further details and would wish to discuss the matter before granting approval.

[17:50] HMT’s Director of Financial Regulation and Industry advises an official to seek a clear explanation from FSA as to why they believed the adjustments to the rules would make Equitable’s returns more accurate. HMT’s Director explains:

As I understand it, adjustments (known in the trade as concessions) are regularly agreed by the FSA, and formally endorsed by HMT under current interim arrangements pending implementation of [FSMA 2000]. It is not our role to second guess the FSA’s regulatory judgement. The only thing different about this case is that [two HMT officials] felt the process should be drawn to Ministers attention, for information, as it involved Equitable.

[18:06] HMT ask FSA for a letter, ‘in straightforward self-explanatory terms (that we can show the [Economic Secretary to the Treasury])’, setting out: what they were proposing; why FSA believed the proposals to be justified; and some context which explained ‘that this is a fairly straightforward procedure/many hundreds are made each year’.

[18:18] In reply, on a question about timing, FSA’s Line Manager E explains that things were getting tight, as companies had to go through a sign-off procedure before submitting their returns by the end of June 2001.

FSA provide HMT with the letter requested about the section 68 Orders sought by Equitable for the value placed on Permanent Insurance and for the rates of interest used in their 2000 returns. FSA’s letter includes the following explanation for the justification of granting the latter Order:

… Most companies live with the consequences of the regulation since the amounts involved are not sufficiently material to affect the overall financial position. However, some companies have sought, and been given, permission to calculate the relevant interest rates on a more reliable basis … While the precise way in which the companies do the calculations varies slightly, they follow similar principles and all produce more reliable figures than the methodology set out in the regulations. For the future, the FSA will be looking to use its rule making powers to replace regulation 69 at an early stage.

The FSA has over the last year or so been looking closely at the way in which Equitable Life prepares its statutory returns and the valuation basis it has used. This has led to some refinements in the calculation of the company’s reserves, most of which it should be said work against the company. The concession above, if granted, would work in the company’s favour for the time being. The company estimates it will improve the presentation of its financial position by around £150 - 200 million. Once such a concession had been granted, we would not allow the company to switch between different methodologies from year to year. Therefore the company would not be able to opt for the methodology that would produce the most favourable result in any given year. For the longer term, we will be looking to impose appropriate requirements on Equitable Life to achieve this. Before doing so there are certain issues relating to consistency that we wish to explore. Those are not matters that are sufficiently material for us to need to hold off with the granting of a reporting concession for the 2000 year end, which would need to be in place in time for it to prepare its statutory returns that must be submitted in June.

[17:32] An HMT official forwards the letter to the Economic Secretary to the Treasury’s office, explaining that the original referral had been for information only because of the ‘general sensitivity of the Equitable case’. She says ‘… the attached note, as I say, seems to set out a pretty clear FSA view that these adjustments are in order. Indeed, it seems that – given the sorts of adjustments that the FSA regularly agree with a whole spectrum of insurance companies (at a rate of around 10 a week) – the FSA would find it very difficult to justify to the Equitable why the current requests should properly be refused’.

FSA’s Chief Counsel A informs Line Manager E that she had now discussed the terms of reference for the Independent Actuary for Equitable’s compromise scheme with Counsel and she recommends that FSA should write to Equitable, saying:

We are concerned that the [terms of reference] for the [Independent Actuary] do not clearly spell out that he should consider the following:

1.the present value of GAR rights under policies (possibly by category of policy or policies);

2.the value of GAR claims for the purposes of the compromise (which will presumably be different from 1);

3.the value of policies for the purpose of voting;

4.whether the actuarial work sets out sufficiently and accurately (so the Court can easily take a view) the impact that the acceptance (or non-acceptance) of the offer will have on the various relevant categories of policyholder within each class.

While we recognise it is difficult at this early stage to set out with [exactitude] or in detail what the [Independent Actuary] should consider, not least because some of the actuarial work will be dependent on the legal conclusions on the classes etc, and there will no doubt need to be some adjustment and clarification as you go along, if you agree that the matters listed above are key issues to be addressed by the [Independent Actuary], we suggest a letter to the [Independent Actuary] supplementing or clarifying paragraph 3 of the [terms of reference] might helpfully be sent to him now.