Submission of the 2000 regulatory returns

Equitable submit their 2000 regulatory returns to FSA. Accompanying those returns are copies of the Society’s annual report and accounts for 2000, prepared in accordance with the Companies Act 1985 and dated 11 April 2001. (See 30/04/2001 [17:13].)

The returns include the following information about Equitable’s business and financial position as at 31 December 2000.

The returns

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

Schedule 1 (Balance sheet and profit and loss account)

Schedule 1 of Equitable’s returns consists of Forms 9, 10, 13, 14, 15 and 17. Form 9 summarises the Society’s financial position at 31 December 2000 as follows:

In Form 13, Equitable set out their admissible assets.

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

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

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

In Form 40, Equitable provide a revenue account.

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

Schedule 4 (Abstract of valuation report prepared by the Appointed Actuary)

In the 2000 returns, Equitable change the presentation of the report of the valuation of their long term liabilities. Instead of presenting a gross premium valuation in the main part of Schedule 4 and a net premium valuation as an appendix, Equitable present a gross premium valuation only.

As in previous years, the results of the valuation are carried forward, unadjusted, from Form 58 to Form 14 and on to Form 9.

Schedule 4 of Equitable’s returns provide the information required by paragraphs 1 to 23 of Schedule 4 to the ICAS Regulations 1996 and includes Forms 46 to 49, 51 to 58, 60 and 61.

Schedule 4 (text)

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

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

In relation to all accumulating with-profits contracts, in paragraph 4(1)(a)(i) Equitable include a slightly expanded description from the previous returns of the circumstances in which – and the methods by which – adjustments could be made to surrender payments. The explanation provided says that:

The purpose of the financial adjustment is to protect the interests of policyholders who are not choosing to surrender policies early while still providing those who are surrendering policies with a fair and reasonable value. The current method of adjustment is to pay a proportion of the full policy value but there is no guarantee that that method will be used in future. In particular the Society has set the financial adjustment at a proportion of the final bonus in the past and may do so in the future or may introduce another method.

In response to paragraph 5 of Schedule 4, Equitable provide 74 pages of information about their linked contracts.

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

Following amendments made to Regulation 72 of ICR 1994, Equitable include a new paragraph in this section on their approach to reserving for surrender values to reflect those amendments. They state:

For accumulating with-profits business the reserve for the amount of a cash payment secured by the exercise of an option to surrender the policy has been calculated as the discounted value of future guaranteed benefits. That amount is consistent with that which could reasonably be expected to be paid if the option were exercised having regard to representations to policyholders, in the event of a significant level of policy discontinuances. The bases to be used in the event of surrender or transfer are not guaranteed and, the primary objective when setting the basis is to protect the interests of the continuing with-profits policyholders.

For with-profit retirement annuity contracts, as in previous years, Equitable state that ‘benefits have been valued on the basis that the benefits will be taken at age 60 or, if that age has been attained, at the valuation date’.

For with-profit personal pension plan contracts, Equitable state that ‘benefits have been valued on the basis that the benefits will be taken at age 50 or, if that age has been attained, at the valuation date’. This is a change from the previous year, where a retirement age of 55 had been assumed (which was itself a change from an assumed age of 60 within the 1998 returns).

Equitable state that a general reserve of £150m was held ‘as a provision to ensure that the valuation is, in aggregate, prudent as required by Regulation 64 and includes consideration of issues such as managed pensions review and possible future improvements in mortality’.

As in previous years, Equitable disclose:

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

Unlike in previous years, the paragraph continues:

It is assumed that adjustments will be made to final bonus to ensure that this remains the case in the future.

Equitable state that they have made an explicit provision for their liability for tax on unrealised capital gains (in relation to business other than that linked to their internal funds), which they now estimate as not exceeding £100.6m. The provision made is £110m, which they say is shown in the Appointed Actuary’s certificate in Schedule 6 of the returns.

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

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

Equitable strengthen the mortality assumptions used when estimating the expected future annuity rates for males that are used to value the GAR liabilities. Equitable also change the valuation rate of interest for the expected future annuity rates to 5¼% for annuities expected to be taken out in the year following the valuation (from 5¾%), with lower future rates for annuities expected to be taken out in later years. This takes account of Regulation 69(9)(a) of ICR 1994.

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

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

In paragraph 7(6), Equitable provide a description of the scenarios that have been tested in order to determine the requirement to hold resilience reserves. They state which of the three scenarios tested produces the most onerous result.

Equitable disclose that a resilience reserve of £1,390m was provided for.

In paragraph 7(8)(a), Equitable disclose the changes made to the valuation assumptions and methods in the resilience scenarios. They explain:

It was assumed that the valuation has been undertaken using the gross premium method as described in section 6(1) for all business except that for with profits business where the benefits are determined from outset in relation to the total premiums payable where a net premium method has been used. The following changes have been made:

1. the interest rates are as stated in Form 57.
2. for all accumulating with profits business, an annual loading of 1.5‰ increasing by 4% per annum compound of the basic benefit was reserved. That is considered to be a prudent allowance for ongoing expenses.
3. the mortality table used for accumulating with-profits pensions business was adjusted to AM80 ult- 5 years.
4. the reserve in respect of the potential liability to tax on capital gains was reduced to £18.1m.
5. no future bonus was assumed which is consistent with the reasonable expectations of policyholders having regard to the current rate of bonus and in the event that experience were to follow the valuation basis.

As Equitable have no longer presented a main and an alternative appendix valuation of their long term liabilities, their response to paragraph 8(d) is different to that provided in previous returns.

Paragraph 8(d) of Schedule 4 to the ICAS Regulations 1996 requires, in respect of non-linked contracts: ‘where, in valuing contracts falling within the circumstances described in regulation 67(1) of the Insurance Companies Regulations, future premiums brought into account are not in accordance with that regulation, such additional information as is necessary to demonstrate whether the mathematical reserves determined in the aggregate for each of the main categories of contract are greater than an amount for each such category calculated in accordance with regulations 66 to 75 of those Regulations’.

Instead of the 112 pages of information that made up the appendix valuation report in the last returns, in the 2000 returns Equitable include one page of information in which they disclose:

For with profits contracts where the benefits are determined from the outset in relation to the total premiums payable a further valuation has been undertaken using the net premium valuation method. The bases employed are in accordance with Regulations 66 to 75 of the Insurance Companies Regulations 1994. The mathematical reserves for that business are lower than those calculated on the methods and bases described in this report and are given below:

Life assurance and general annuity business:

Pension business:

Equitable go on to state:

The mathematical reserves determined in the aggregate for all categories of contracts referred to in sub-paragraph (d) above represent less than 5% of the total mathematical reserves (after deduction of reassurance cessions) for all non-linked contracts. The mathematical reserves for each category of contracts are greater than the mathematical reserves that would be determined on a net premium reserving basis.

In paragraph 12, Equitable describe the IRECO reinsurance treaty. Equitable disclose that the treaty now comes into effect where the proportion of policyholders taking an annuity at their guaranteed rate exceeds 60% (previously 25%) of total retirements in that year. They also disclose that the premium payable since the last set of returns was £797,675 (previously £850,000).

In paragraph 13, Equitable disclose: ‘The Society has no business where the rights of policyholders to participate in profits relates to profits from particular parts of the long term business fund’.

In paragraph 14, Equitable set out a statement of their aims with regard to bonus distribution and of how they maintain equity between different generations of policyholders. The information provided on the stated principles underlying their approach is the same as that provided in the 1998 and 1999 returns, with the addition of the following paragraph:

… following the House of Lords’ judgment guaranteed annuity rates (where applicable) are applied to the full policy value (including any final bonus element). Where those guarantees mean that the value of benefits taken is greater than the asset share then this additional value is paid for by a reduction in the asset share for all with-profit policyholders.

In paragraph 15, Equitable disclose that (except for German policies) no bonuses have been declared for 2000. They also state that:

Although the valuation allows for the declaration of bonuses as set out in 6(1)(e) no declared bonus is currently being declared, and this position is likely to continue throughout 2001 and for some period thereafter.

In paragraph 16, Equitable set out final bonus rates. Under the heading ‘Maintenance of Final Bonus Rates’, Equitable disclose:

The directors reserve the right to reconsider the rates of final bonus at any time. In particular directors will need to ensure that the final bonus policy and the level of any financial adjustment are such as to allow the Society to maintain its solvency.

In paragraph 21(2), Equitable disclose:

The rates of interest on fixed interest securities have been determined using the aggregate yield basis, i.e. by calculating the rate of interest as the rate which equates the discounted value of the aggregate cash flows. The fixed interest portfolio (excluding convertible fixed interest securities) has been separated into two segments of securities which have like attributes (being the categories on Forms 48 and 49), i.e.

• approved fixed interest securities, and
• other fixed interest securities.

In explaining the description of the method by which the yield on assets other than equity shares and land was adjusted in accordance with regulation 69(7) of ICR 1994, unlike in previous years, when the maximum yield was given, Equitable state:

The yields on non-approved fixed interest securities have been reduced having regard to the credit rating of each security. The reduction in yield is calculated according to the following table:

Where stocks are unrated an appropriate rating was ascribed.

Schedule 4 (forms)

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

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

Form 48 shows that 51% of Equitable’s non-linked assets are invested in equities, 7% in land, 34% in fixed and variable interest securities and the remaining 8% in a variety of other assets.

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

In Form 52, Equitable set out the mathematical reserves held for accumulating with-profits policies, along with information on the number of contracts in force, the benefits guaranteed, and the rates of interest and mortality assumptions used in valuing them. The mathematical reserves are not discounted from the current benefit value. The Form 52 for ‘Pension business’ discloses that the gross total reserve for ‘Options and guarantees other than investment performance guarantees’ (i.e. the reserve for annuity guarantees) is £2,631m. The form also shows that this reserve has been reduced by reinsurance of £808m to a net total reserve of £1,823m.

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

In Form 54, Equitable set out the mathematical reserves held for the various types of index-linked contracts, along with information on the number of contracts in force, the value of current benefits, the level of benefits guaranteed on death or maturity, and the rates of interest and mortality assumptions used in valuing them.

In Form 57, Equitable provide matching rectangles, illustrating the notional allocation of assets to each category of liabilities, showing the valuation rates of interest supported, and the ability of the matching assets to cover the reserves in the resilience scenarios.

In Form 58, Equitable set out the valuation result and composition and distribution of fund surplus.

Supplementary notes to the returns

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

Equitable disclose that they have been granted a section 68 Order which permits them to take into account a future profits implicit item. The Society states that it had included an item of £1bn and that this was within the maximum amount permitted by the Order.

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

In relation to the admissible assets disclosed in Form 13, Equitable state:

The Treasury, on the application of the Society, issued to the Society in February 2001 an Order under section 68 of the Insurance Companies Act 1982. The effect of the Order was to enable the Society to complete Form 13 as if the permitted asset exposure limit for shares and hybrid securities issued by [a named company] was 3.25% of the long term business amount.

Also in relation to Form 13, Equitable state:

The Treasury, on the application of the Society, made in June 2001 an Order under Section 68 of the Insurance Companies Act 1982. The effect of the Order was to provide that the value to be ascribed to the Society’s holding of shares in Permanent Insurance Company Limited was to be the amount agreed to be paid for the shares by Liverpool Victoria Friendly Society Limited.

In relation to Form 14 and ‘Charges, Contingent Liabilities, Guarantees, Indemnities and Contractual Commitments’, Equitable disclose that they are to undertake a review into whether there had been any mis-selling of Managed Pension policies. They say that, should the review find that mis-selling occurred in all cases, the liability would be up to £200m. Equitable state that any costs would be met from their general expense reserve of £150m.

Also in this section of the returns, Equitable state:

Subsequent to the House of Lords’ decision in the case of Equitable vs Hyman in July 2000, a number of enquiries by various regulatory and professional bodies and other parties have been instigated including the Treasury Committee of the House of Commons. In those proceedings and elsewhere, certain policyholders have indicated they believe that they have grounds for an action against the Society for mis-selling of business due to the non-disclosure of the guarantees to GAR policyholders. There is the further possibility that other causes of action may arise. It is not possible to assess the impact of the outcome of these matters, if any, on the financial position of the Society and no provisions for contingent liabilities have been made.

A fundamental uncertainty exists in respect of the outcome of any actions that may be initiated against the Society as a consequence of matters emerging from the various regulatory and other enquiries in progress, which are noted above.

Equitable also disclose that:

In respect of policies with guaranteed annuity rate options, the House of Lords’ decision will have an impact on the decisions of policyholders in the future as to the extent to which they continue to pay future contributions. The reserves have been calculated based on the limited experience to date but are substantially more prudent than this experience would indicate. There is fundamental uncertainty as to whether the future decisions of policyholders will conform to the assumptions made. As a result, the reserves could be either overstated or understated with a corresponding effect on the excess of available assets, and implicit items, over the required minimum margin.

As in the previous year, Equitable disclose:

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

In relation to the Form 57 matching rectangles and the determination of the rates of interest on fixed interest securities, Equitable provide a supplementary note that:

The Treasury, on the application of the Society, made in June 2001 an Order under section 68 of the Insurance Companies Act 1982. The effect of the Order was to require the Society to calculate the rates of interest to be used in determining the present value of future payments for approved fixed interest securities and other fixed interest securities (other than convertible fixed interest securities) on an aggregate yield basis. The aggregate yield equates the discounted value of the aggregate cash flows on such fixed interest securities with the total market value of such securities.

Schedule 6 (Certificates by directors, actuary and auditors)

Equitable provide an additional statement in the returns on matters relating to the certificates of the Directors and Appointed Actuary. They say:

The decision of the House of Lords on 20 July 2000 relating to Guaranteed Annuity Rate policies, had a material impact on the Society’s financial position. It substantially reduced the level of free assets held in excess of the margin of solvency required by section 32 of the Insurance Companies Act and led to the closure of the fund to new business.

The certificates on the following pages, which should be read in conjunction with this statement, report on the position of the Society following the House of Lords’ judgement using the actuarial bases and economic assumptions disclosed in Schedule 4. The bases carry margins of prudence beyond the Society’s relevant experience. However, attention is drawn to the fundamental uncertainties in relation to the Guaranteed Annuity Rate “GAR” options and contingent liabilities that may arise from any actions that may be initiated against the Society as a consequence of matters emerging from the various regulatory and other enquiries in progress. These matters are described in supplementary note 1402 to these returns.

The closure of the Society to new business will result in an altered pattern of maturity and other claims which will require active management of the assets and liabilities. The successful implementation of the proposed compromise scheme in relation to GAR obligations and the possibility of further payment of consideration by Halifax Plc would also affect this future position.

Equitable explain that the signatories to the certificates did not work for the Society during any part of the year 2000. Therefore, the certification had been made to their best knowledge and belief.

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

FSA’s Legal Adviser D asks Scrutinising Actuary F whether Equitable’s reserving requirement is based on the assumption of a 90%, 95% or 97% take-up of GARs.

[11:33] The Actuary advises that Equitable had assumed an 85% take-up rate in their 1999 returns, which had been increased to 90% for the 2000 returns, following challenge from GAD.

Equitable’s Chief Executive writes to FSA about the current level of policy values to available assets. The Chief Executive says:

On page 323 of the returns … there is disclosure of the need for active management of the assets and liabilities of the Society as a result of its closure to new business.

The Board recognises that there was an excess of policy values over available assets of approximately 10% at 31 December 2000. In accordance with valuation regulations no allowance is made for final bonus within the mathematical reserves.

In 2001 the Society has benefited from the sale proceeds for the partial disposal of its business to Halifax PLC, but investment returns have been poor due to market conditions. When combined with the continued accumulation of bonus at 8% p.a. during the current year, the excess of policy values over available assets has increased. In normal investment conditions the Society intended to reduce the excess over a reasonably short period of time. However, in view of market conditions, and the relatively high level of claims that have been experienced since the Society closed to new business, the Board considers that a more immediate reduction in this excess is required.

Further work is being carried out to enable the Board to decide upon the appropriate action in the very near future. We will keep you advised of decisions in relation to this issue.

On a copy of the letter sent to Legal Adviser A by Chief Counsel A, the 8% bonus rate has been underlined and marked with ‘!’.

In an undated note, Legal Adviser A provides Chief Counsel A with his understanding of what this means, that being:

… as far as I can sort out is that the value of the policies exceeds the assets ie they would be insolvent on a realistic basis. However, they would be solvent under the ICA because they do not have to reserve for terminal bonuses.

As they [are] increasing the value of policies by 8% which is above the investment return the position is worsening. They then have to reduce this 8% but in a way in line with PRE.

I don’t [think] this requires immediate action on our part (they have not reached the [required minimum margin]) but we need to know what they are going to do. So yes I think it does sound O.K.

FSA’s Line Manager E circulates a note on the position that has been reached following ‘a number of parallel discussions’ about Equitable’s letter and their 2000 returns. The Line Manager says that:

Paragraph 16 of Schedule 4 to the Accounts and Statements regs require the returns to include

“a statement of the practice regarding any bonus payments … to be made on claims arising in the period up to the next investigation …”

From discussions with [the Head of Actuarial Support] and [Scrutinising Actuary F], we all think that there is a case for arguing that the drafting of the returns as they stand (ie referring to the interim rate of return at 8%) on the basis that was the rate that applied at the time of the submission and no formal decision to amend the rate had been taken. It is implicit that by being an interim rate, it is subject to revision at any time.

That said, we are all of the view that it would be preferable, if it were not logistically difficult to do so, if the wording of the statement could be amended slightly to say something along the lines that “the rate is currently 8% but that it is regularly reviewed to take account of external factors such as market conditions.” None of us think there is any need for the returns to be any more explicit about the current position. By extension, I assume that [FSA’s actuarial department] would share my view that against that background a statement of the kind proposed submitted around the same time as the returns would not cause us difficulty.

Perhaps [Legal Adviser A] or [Chief Counsel A] could let us know before the meeting if they take a different view on any of the above conclusions.

[23:03] In response to this, Chief Counsel A says to Line Manager E: ‘We discussed. [Legal Adviser A] and I think something should be said about a review. Mentioning external review might be misleading as might a reference to a “regular” review’.

Further to Line Manager E’s note of 25/06/2001 [16:46] and the Head of Life Insurance’s note of 26/06/2001 [11:44], FSA’s Insolvency Practitioner puts forward his thoughts (under the title ‘Basis for the FSA’s Intervention in Equitable Life’s Scheme’) on the test that FSA ought to apply in assessing the compromise scheme. The Head of Life Insurance explains his view that:

… it is important to focus on what the FSA’s role is in this situation. It is not to decide whether the scheme is fair or unfair, reasonable or unreasonable. The scheme is a compromise between groups of creditors and the company. It is not for the FSA to say that an uplift of 20% or 30% is a fair value of creditors’ rights. There are unquantifiable benefits of the scheme that will sway creditors and different creditors will perceive different factors as important. It is therefore futile to try to arrive at a judgement of overall fairness for the scheme. Following this, I believe that the FSA should not be concerned with whether policies are valued in the scheme on the basis that each policyholder will exercise his GAR options so as to maximise the value of the policy in actuarial terms, or whether the policies are valued after making an assumption about the realistic take-up rate of GAR benefits. (The exception to this is the value for voting purposes, which I come to later.)

The Insolvency Practitioner suggests that there are two parts to FSA’s role ‘which derive from the principles of consumer protection and treating customers fairly’. First:

The scheme promoted by the directors should have a reasonable prospect of being approved.

The scheme offers overall benefits in the Halifax consideration and investment freedom. It is right that these benefits are not lost by the directors promoting a scheme so skewed as to stand no chance of general acceptance or so late as to miss the March 2002 deadline. In my view, this is the limit of the “reasonableness test”.

The second part suggested by the Insolvency Practitioner is that:

The information available to creditors and the High Court should be adequate to enable each to assess the effect of the scheme on his rights and compare this to the alternatives to the scheme. Because of the safeguards mentioned below, I think this is all that is required for the company to “deal fairly” with policyholders.

The Insolvency Practitioner sets out the aspects of this in relation to policyholders and to the High Court. On the former, he says:

1. The scheme explanatory statement should state what the alternatives to the scheme are and what the board intends to do if the scheme is not approved. The next best alternative is clearly to continue to run off the closed fund for so long as it is solvent (and also if it is marginally insolvent). The explanatory statement should illustrate (and try to quantify) the benefits which flow from greater investment freedom. The explanatory statement should explain the consequences of liquidation and attempt to quantify this. There should also be a statement as to the prospects of transferring the business to another fund or obtaining other capital support (presumably nil, unless Halifax has a change of heart).
2. Each policyholder should have a personalised statement showing the value of his policy: for voting purposes, if the scheme is not approved, and if the scheme is approved. This should take into account the benefits of the Halifax consideration and greater investment freedom, and it should give a range of values to illustrate the sensitivity to interest rate assumptions.

We need to specify now for the Society the minimum standard of personalised information we think a policyholder should receive, since it will take time to build the systems to produce the calculations. I think we could accept some generalised illustrations, but there must be enough examples for there to be one appropriate to each policyholders’ circumstances, in particular, there must be one for policyholders for whom the scheme is not advantageous compared to carrying on without the scheme.

Under the heading ‘Can no-one be worse off than they would be under no compromise?’, the Insolvency Practitioner writes:

It is possible for the scheme to be a win-win for GARs and non-GARs compared to no scheme if the non-GAR’s share of the Halifax consideration conditional on the scheme being approved and the greater investment returns possible after removing the uncertainty over the quantum of GAR options is removed exceeds the compensation paid to GAR policyholders for removing the maximum value of their options. However, I think that the sums do not quite work.

A crude calculation obviously, but I think that the Society should make some attempt at quantifying the benefits of increased investment freedom.

[14:23] Line Manager E notes the Insolvency Practitioner’s views:

… on the rigour (or lack of it) with which we should test the proposals and I can see that is justifiable on the basis of our specific statutory role in a case such as this. However, we are empowered more generally to act if we consider there is a reasonable expectation that policyholders reasonable expectations may not be met.

However, Line Manager E believes that FSA should recognise that ‘many policyholders will be either unwilling or unable to [‘reach a view on the acceptability or otherwise of the proposals’] and that they will be expecting some guidance about whether they should sign up, or at least whether it would be reasonable for them to contemplate doing so’. Line Manager E says that FSA ‘must be reasonably testing’ of Equitable’s proposals and that their tests should be:

•   a vertical test, comparing the outcome after a scheme with the other possibilities (of  which winding up and continuation of the status quo are the most relevant);
•  a horizontal test, to see how the treatment of groups of policyholders compares and  also how the scheme would impact on policyholders within those groups (insofar as  that can be predicted);
• a general “is it a reasonable scheme for someone to come up with?” test.

Line Manager E seeks comments on these proposed criteria and asks whether he could give Equitable a general idea of FSA’s thinking.

FSA meet Equitable to discuss their letter of 28/06/2001. According to FSA’s note, Equitable’s Chief Executive:

… explained that terminal bonus rates were not currently sustainable. The problems in part stemmed from the nature of the society’s business which, because it had only a relatively small proportion of annual premium business, meant that putting the business in run off meant that the long term fund went rapidly into decline. (Normally a life office would expect the fund to continue to grow for a period before starting to decline, which enables it to cope better in difficult market conditions.) There was also a problem because of the flexibility in many contracts that meant that pension contracts allowed people to take out their funds during a wide window of opportunity.

Equitable’s Appointed Actuary:

… said that they would need an investment return of 2% for the year as a whole (it is currently negative) just to keep their heads above water. They had thought that they would elect for a material reduction in the rates of interim bonus for the time being, but the position was now such that that did not deliver what was needed. Policy values have grown by about 10% too much compared with the underlying assets.

Equitable inform FSA that their:

… Board discussed the issues on Wednesday (27/6) and has resolved to take action. A further board meeting has been called for Monday 2/7 at which a range of options will be considered. As noted above, at one stage, the solution was thought to be … to cut interim bonus rates from 1 August 2000 onwards, although that was now unlikely to be enough as it would simply produce a cut of about 7% and further action would be needed. Realistically therefore, it was thought that more drastic steps would be needed. One option being considered would be to remove some of the transparency from the process by which terminal bonus is added to pension plans from year to year. Effectively the proposition was that they would cease to show the rate of accrual of the non-guaranteed terminal bonus. This would be consistent with the practice for much of the industry and some other types of Equitable Life policy, but it was a clear step back into opacity which would not go down well. It could be seen as a mechanism for frustrating the GAR. The alternative would be to deliver a cut to policy values by some means to bring them more closely back into line with the underlying assets. This could be done by reducing the amount of accrued terminal bonus, or by making a reduction in the overall policy value, but so as not to take the value below the guaranteed value in any individual case. Either approach would be difficult, and in order to sell this course of action they thought that they would have to be explicit

that they would look to restore the bonuses if and when financial markets improve.

Equitable’s Chief Executive confirms that ‘if there were a significant rebalancing of policy values, they would expect to reduce the financial adjuster on non-contractual terminations, perhaps to 5%’.

How this impacted on Equitable’s 2000 returns is discussed and FSA say that they:

… thought some disclosure would be needed because of the requirements under the regulations for the actuary to comment on bonus rates for the current year. We thought that avoiding the issue would be particularly difficult if the board might have met and decided on a course of action by the time the statutory returns were in the public domain. Equitable did not disagree with our view and it was concluded that this could best be dealt by a modification of the appointed actuary’s report. However, they did believe that there was a need for some caution if the information was not to be misinterpreted since this could cause panic and simply make the position worse. We agreed to acknowledge receipt of the letter, so that [Equitable’s auditors] could be clear that we had been notified of the position … Equitable agreed to show us a form of words that might go in the report.

FSA record that they:

… also discussed briefly the issue of the term in GAR pension plans that allowed the Society to determine the terms on which future premiums would be accepted if a policyholder ceased to pay premiums in a policy year. Previously the Society had allowed policyholders to continue to enjoy GAR benefits for future premiums. However, they took the view that they were now obliged to enforce the contract terms and that this should include not allowing those who had missed premiums to continue to benefit from the GAR in future. We noted our concerns about whether there would be PRE issues. [Equitable’s Appointed Actuary] noted that there were the interests of non-GAR policyholders that needed to be respected. He also noted that there had been no reason for the Society to apply different terms to subsequent premiums prior to the House of Lords judgment. The situation had now changed, so he argued it was acceptable for such steps to be taken. Equitable agreed to provide a copy of their legal advice on the issue. They indicated that any change of this kind would take a couple of months to implement.

As agreed at the meeting that morning, FSA write to Equitable in reply to their letter of 28/06/2001. FSA say:

You explained to us that the Board has resolved to take action to address the position at a very early stage and that it is due to meet again early next week to consider the courses of action available. I should be grateful if we could meet again as soon as your Board is clearer about the precise action it intends to take so that the FSA may satisfy itself that there is no regulatory obstacle to, or indeed need for modification to, that action. In the meantime, we concluded that appropriate disclosure of the position, and of the need for action to address it, ought to be made in the statutory returns that are due to be submitted by 30 June 2001. We agreed that this should be done by way of a statement to be included in the report of the appointed actuary. Since the meeting you have provided a copy of the form of words he proposes to use and I can confirm that the FSA considers that wording acceptable.

Equitable’s auditors for the 2000 returns write to FSA, stating that they ‘consider that in accordance with the Auditors (Insurance Companies Act 1982) Regulations as amended by the Financial Institutions (Prudential Supervision) Regulations 1996 and Statement of Auditing Standards 620, we are obliged to specifically draw to your attention the contents of [Equitable’s letter of 28/06/2001] in the context of Regulation 22 Schedule 4 Para 5(4)(a)(iv)’.