August 2001

FSA’s Director of Insurance sends the Head of Life Insurance a paper that had been drafted on 28/07/2001 [20:52], which sets out the action that might be necessary to prevent Equitable reducing guaranteed amounts payable under their policies. Attached is a Notice under section 45 of ICA 1982. The Director notes that the paper and accompanying section 45 Order had been ‘in the event not used. But you may need for your files’.

Line Manager E writes to FSA officials about outstanding issues. The Line Manager informs officials that Scrutinising Actuary F had written to Equitable on 19/07/2001, and the Society had replied on 20/07/2001 [17:46]. He attaches Equitable’s reply, split into three documents, named ‘solvency statements’, ‘future profits’ and ‘general’. The Line Manager says:

Also in the package is the application for the renewal of the section 68 order for future profits, which Equitable are asking to be increased to £1.1 billion for 31 December 2001. We received that application at the time the last returns were submitted, but had not previously received the actuarial certificate of 28 June that is now included in the package. I have to say I am not entirely persuaded that it is reasonable to rely on the historic profits that arose in a trading company as opposed to the likely future profits that will arise in the company in its current state. Perhaps [Scrutinising Actuary F] could [advise] on his return about the likely technical acceptability of the continued use of the implicit item in 2001, taking into account what we consider the position might look like by the year end.

Line Manager E goes on:

We have also received in the package the outstanding monthly solvency reports, covering April, May and June, showing a surplus over the [required minimum margin] of £850m, £650m and £660m respectively. However, the covering letter mentions that when the markets fell to 5320 on 19 July, they thought that the surplus had just about been eliminated. Since then of course the FTSE 100 fell slightly further, hitting a low around 25 July of 5220.

[10:54] The Head of Actuarial Support says that Scrutinising Actuary F would look at this in more detail on his return. The Head of Actuarial Support also comments: ‘As you say, there are no obvious showstoppers, but the cover for the margin of solvency looks very thin at present, (after making a resilience provision but before allowing for potential mis-selling costs)’.

[18:29] Line Manager E thanks the Head of Actuarial Support and says that he had not been trying to chase a reply as he ‘thought there were some things in the response that needed to be aired, though I did try to circulate the letters in a way that suggested the routine regulatory team already had things in hand. The lack of interest suggests I was probably successful!’.

At some point, the Director of Insurance replies to Line Manager E saying:

Between [19 and 25 July] the Society was selling equities – including, I think £1bn of overseas equities. We will need to see whether this kept them the right side of the line. I think it must have done since the [Appointed Actuary] was able to advise the Board, and the Chairman to advise us on 29/7 that its margin was intact, even taking into account potential misselling claims.

FSA meet Equitable. (Note: FSA’s files do not contain any note which they had themselves prepared of this meeting. Also, it is unclear which documents were handed to Equitable at the meeting and which were the subject of the discussion.) According to Equitable’s note of the meeting (which was sent to FSA on 7 August 2001 and subsequently confirmed, on 14 August 2001, to be an accurate record), at the meeting:

• FSA handed over a draft of a letter requiring Equitable to commission their Appointed Actuary’s company to investigate the amount of mis-selling liabilities. Equitable record that: ‘the objective is to deal with the problem that the FSA is unable to obtain independent actuarial support. FSA will obtain the information they need by having access to the work [the Appointed Actuary’s company] are to do for ELAS’. FSA note that they were seeking the data so that they could undertake their own analysis.
• FSA provided a draft of the monthly financial reporting that they would like to receive from Equitable. Equitable note that no insurance company carried out a full data analysis more than once or twice a year and so the quality of more regular data would be limited. FSA say that they were seeking the information that Equitable used to inform their decisions to ‘continue the business’.
• Equitable record:

[FSA’s Insolvency Practitioner] said they would like to have an end of June position confirmed by [the Appointed Actuary’s company] together with a monthly “roll forward”. He wants to see Balance Sheets on Companies Act and Insurance Act basis showing the level of free assets. He provided some draft schedules to help explain his proposal.

[Equitable’s Chief Executive] noted that the proposed Question 9 was very sensitive information which could be very damaging to members’ interests if it leaked. There was general agreement that an indication (“thin” or “very thin” etc) could be given orally instead.

[FSA’s Line Manager E] said that the FSA are open to suggestions as to what data is provided formally and informally.

When confirming the notes of the meeting as accurate, the one point that FSA raised about Equitable’s notes of the meeting was that FSA thought ‘the words in brackets [“thin” or “very thin” etc] are too specific and restrictive as a description of the sort of oral indications which we will expect to receive’. FSA suggest that the words should be deleted.

• It was agreed that the draft proformas of the information that FSA wanted represented proposals and that FSA and Equitable should aim to agree the reporting requirements by 3 August 2001.
• FSA asked whether mis-selling claims would fit into the compromise scheme. Equitable say that they would either be part of the scheme or run parallel to it. Equitable say that they would report further on this in the following week.

Further to the Insolvency Practitioner’s note of 28/07/2001 [12:34] on mis-selling  quantification, Chief Counsel A asks the Director of GCD if anyone had considered the negative effect of bringing forward the liabilities: ‘eg including them in a GAR/non-GAR scheme or otherwise crystallising them now by some other legal mechanism’.

[16:36] The Insolvency Practitioner explains that FSA had brought in a tax expert who would consider the issue.

[18:09] Chief Counsel A questions whether it should be assumed that the tax expert would be considering the issue. The Chief Counsel says that she would raise the issue up with Chief Counsel B. (Note: Chief Counsel A later (on 6 August 2001 [at 20:43]) suggests to Chief Counsel B that they should leave the issue, as it would ‘come out in the wash’.)

FSA’s Chief Counsel B writes to the Head of Actuarial Support about a calculation that he had  provided regarding Equitable’s mis-selling provision in a ‘Rational Worst Case Scenario’. FSA’s Head of Actuarial Support’s calculation concludes:

There is of course still considerable uncertainty about a number of these assumptions and the value that can be placed on the different elements of the calculation. It does though seem that a “rational worst case” scenario could result in a provision of around £1.5-2.5 billion, though we could not rule out the possibility of the Courts taking an even worse interpretation (eg on assumption (4) above which could add another £500m-£1Bn, or on assumption (10) which could add a further £1 billion).

The implication would be that even if they could find just enough free reserves to cover this, they would have to make substantial cuts in the bonuses for [GARs] which could conceivably result in counterclaims from this block of policyholders which would be even more difficult to meet.

Chief Counsel B says that there was much that needed to be explained about the calculation and asks for a meeting to discuss the matter.

[15:05] Chief Counsel A says: ‘I suggest I attend any meeting. Looks like [the Head of Actuarial Support] and I might helpfully agree a short note which could iron out some of these issues’.

[15:35] The Head of Actuarial Support replies:

Let me hasten to reassure you all that these very tentative figures (on a note headed “Draft”) were based on an initial analysis of what the worst case on [the Society’s Counsel’s initial basis] might imply, ie the higher basis of quantification that he proposed in his draft opinion, and not the lower basis which [the FSA’s Counsel] has now suggested may apply. This has necessarily included a long list of assumptions that would need to be refined.

[17:39] Chief Counsel A writes:

[Head of Actuarial Support], We had a quick chat. It may be helpful to copy recipients to know the following:

1.As you say below, you were doing no more than beginning to think about the figures at one end of the continuum (best case to worst case scenario for Companies Act reserving). A lot more work is needed (with input from others) before ELAS (or FSA) can come to a view.

2.You were assuming that compensation would be based on an industry comparator (not the cost of GARs).

3.Many of your worst case scenario assumptions are highly debatable.

4.In any event, Companies Act reserving is not required to be on a worst case scenario basis.

5.Finally, even if the worst case scenario was eventually accepted to be as you have outlined (in draft!) and ELAS were to reserve on that basis, there are options available to ELAS to maintain solvency (eg, further reducing bonus or shifting into gilts).

[18:04] FSA’s Head of Actuarial Support concedes that he agreed but notes that FSA ‘would of course need in that hypothetical worst case eventuality to talk through the possibilities in paragraph 5 in more detail, and see to what extent their solvency position could be improved and policyholder expectations fulfilled. (There is insufficient information at this stage to make a proper assessment on this, given the wide range of uncertainties)’.

FSA’s Line Manager E informs colleagues that a meeting with Equitable to discuss the Compromise Scheme and how they would use it to deal with mis-selling planned for the following day - had been postponed until the following week. The Line Manager explains that Equitable were not yet in a position to discuss mis-selling, and that therefore the meeting had had to be postponed.

[18:52] The Director of Insurance writes to the Head of Life Insurance in reply, expressing his concern that Equitable were ‘slipping again’ on the Compromise Scheme. The Director of Insurance suggests that they should meet, along with other officials, at the end of each day to discuss progress and priorities and to agree action for the following day.

The Director says that he would also like to discuss with the Director of GCD how FSA should progress the Article 4 issues in his absence.

In response to the query of 31/07/2001 [16:34], Legal Adviser E provides a note on Article 4 of Equitable’s Articles of Association and its interaction with the permitted links regime in ICR 1994. The advice given, in summary, was that:

a)it is not clear that [Article] 4 is caught by [Regulation] 43;

b)if [Article] 4 is caught, however, the conclusion must be that, since it determines policyholder benefits, it is a core term of the relevant contracts;

c)illegality in respect of a core term of the contract renders the contract as a whole illegal and unenforceable by either party;

d)in relation to a core term tainted by illegality, the scope for severance of the illegal term and the enforcement of the balance of the contract without it is limited;

e)the better conclusion, in my view, is that Article 4 is not amenable to challenge as a prohibited link, is not a core term and remains amenable to possible challenge on other grounds, for example as an unfair contract term.

FSA’s Chief Counsel B draws attention to the Policyholders Protection Board’s solicitor’s letter of 30/07/2001 and that:

… what [they] say in relation to the question we asked them concerning the valuation of policy benefits in a liquidation and in particular the valuation of a policyholder’s expectation of a future benefit.

The simple point made by [the solicitors], and I think this has some force, is that where the valuation rules are being applied in a liquidation of an insolvent company the policyholder’s future expectations should probably fall to be treated as having a nil value at least to the extent that any future benefit is dependent upon distributions from profits. The position would be different however were the Equitable to be wound up on a solvent basis and where there were assets attributable to the payment of future bonuses. This would suggest, that if the Equitable were wound up on an insolvent basis then the [Policyholders Protection Board] would be looking to pay 90% of the guaranteed contractual benefits but probably no more.

FSA’s Legal Adviser A provides advice on Equitable’s reserving requirements in relation to their  assumptions on annuity guarantee take-up rates. The advice given was as follows:

1.In 1998 [Chief Counsel A] gave some preliminary comments on the application of Part IX of the Insurance Companies Regulations. In particular on the proposition that the regulations require Equitable to reserve as though 100% of its policy holders will choose to take the guaranteed annuity offered under the relevant policies. Much water having passed under many bridges, [Chief Counsel A] has asked me to look again at the matter.

2.In suggesting that Equitable should reserve on the basis of a 100% take up rate, reliance was placed on regulation 64 of the 1994 Regulations. Regulation 64 sets out a general principle. The amount of the liabilities shall be made on actuarial principles and shall include appropriate margin for adverse deviation of the relevant factors. The liabilities must be determined in compliance with each of regulations 65 to 75.

3.It is not clear that any of the other regulations are relevant. In particular, regulation 72 provides that provision shall be made on prudent assumptions to cover any increase in liabilities caused by the exercise of options. In this case, the exercise of the option will not serve to increase the liabilities.

4.As I understand the present position, take-up rates are in the region of 60% by value but c. 90% by number. The present reserving is on the basis of just under 100% take up with the reduction below 100% taking into account certain mortality assumptions.

5.We recently took the advice of [Counsel] as to whether it was necessary to reserve on the basis that policyholders took benefits at age 50. Although in the end this was determined by the construction of regulation 72(3), [Counsel’s] advice was effectively that reserving on a worse case scenario was not required.

6.In these circumstances, it is not clear to me that there is anything in the regulations that require the present level of reserving and that a lower level of reserving is permissible if that is prudent. I shall be happy to reconsider in the light of any comments.

An HMT Director writes to an HMT official (copied to the Chancellor of the Exchequer’s  Private Secretary and others) about advice which had been given by the Civil Service pension scheme advisers that group schemes should consider stopping paying new money into Equitable and should ask for bulk surrender values. The Director says that the Civil Service pension scheme wanted to send their members a copy of the report, along with the latest guidance from the National Association of Pension Funds. The HMT Director writes:

My clear view was that (i) we could not give public service pension schemes any information which was not generally available; (ii) the managers of public service pension schemes had to take whatever action they believed appropriate in the light of their statutory and contractual duties.

… However, this news clearly has implications for Equitable. I have discussed these with [Managing Director A] at the FSA. His view is that there should not be an immediate problem. Asking for a bulk surrender value will take [some time], and, within their rights, Equitable would be likely to make such a transfer pretty unattractive. It was not therefore “today’s problem”. The publicity which might follow wider circulation of the [adviser’s] report would not be good but there were many reports of this sort floating around. He did not know the value of the [Principal Civil Service Pension Scheme] stake but thought it would be pretty large. FSA were any way keeping an eye on withdrawals.

FSA’s Director of GCD provides Chief Counsel B with comments on his draft guidance about  Counsel’s opinions on mis-selling liabilities.

[13:03] In response to a point raised about the existence of separate funds or sub-funds, the Head of Life Insurance asks the Head of Actuarial Support to produce a definitive note on the actuarial complexities of the management of a long term fund.

[14:33] The Head of Actuarial Support points out that he was not an expert in insolvency law for insurers but offers his understanding that ‘Section 55 of ICA 82, in conjunction with the 1985 Winding-Up rules, disapplies the normal rules for the operation of a long-term fund in the event of a winding-up’. He goes on to explain the issue in more detail.

The Treasury Solicitor’s Department send FSA a note on the scope for using powers under  section 45 of ICA 1982 to require Equitable to act on HMT’s/FSA’s interpretation of Article 4 of Equitable’s Articles of Association. HMT attach an amended draft Notice that could be used. The advice provided included the following:

In my view, section 45 could be used to require [Equitable] not to rely on the wider interpretation of Article 4 – or strictly, of any provision made in accordance with that Article in a policy granted under those Articles – but only on the basis of section 45(1)(b) and on the ground in section 37(2)(aa), coupled with paragraphs 5 and 7 of Schedule 2A to the Act. I do not consider that section 45(1)(a) and the ground in section 37(2)(a) could be relied on, as suggested in last weekend’s draft. My reasons for this view are as follows.

Sections 45(1)(b) and 37(2)(aa) allow a requirement to be imposed on a UK company “for the purpose of ensuring that the criteria of sound and prudent management are fulfilled with respect to the company” on the ground that any of those criteria “is not or has not been or may not be or may not have been fulfilled”. Those criteria are defined in section 5(4) as the criteria set out in schedule 2A; paragraph 5 of Schedule 2A specifies one of the criteria – somewhat tautologically – as that the company “conducts its business in a sound [and] prudent manner”, and paragraph 7 then states that a company is not to be regarded as fulfilling this criterion “if it fails to conduct its business with due regard to the interests of policy holders”.

It seems to me that HMT/FSA could properly take that view that it would not be in the interests of policy holders for [Equitable] to cease to meet in full the contractual entitlements of its policy holders, or to act on an interpretation of Article 4 and provisions made under it according to which [Equitable’s] liabilities to those policy holders were regarded as reducing in line with its net assets.

It follows that if [Equitable] were to act on such an interpretation or to cease to meet those entitlements in full, under paragraph 7 of Schedule 2A HMT/FSA could properly consider that the criterion in paragraph 5 of that Schedule “is not fulfilled” with respect to [Equitable]. That would mean that the ground in section 37(2)(aa) was established. Equally, if it appeared to HMT/FSA that [Equitable] may be going to act on such an interpretation or to cease paying out in full, the ground in section 37(2)(aa) would be established on the basis that the criterion in paragraph 5 “may not be … fulfilled” with respect to [Equitable]. In either of those circumstances, imposing a requirement on [Equitable] not to act on interpretation, or to continue to meet its contractual obligations so far as possible, would clearly be “for the purpose of ensuring that the [criterion in paragraph 5 of the Schedule is] fulfilled with respect to the company” within section 45(1)(b).

Sections 45(1)(a) and 37(2)(a) are about protecting policy holders against the risk of a company being “unable” to fulfil their reasonable expectations. That might include, for example, obliging a company to invest differently (or not to change certain investments) if its current investment policy (or such a change) would be likely to leave it with too small a fund to meet those expectations. Those sections do not seem to me to enable a requirement to be imposed which does not affect an insurer’s ability to meet policy holders’ reasonable expectations, but merely obliges the insurer actually to meet those expectations.

The requirements being proposed here fall in my view into the latter category. A requirement to meet contractual entitlements in full or to act on an interpretation of Article 4 under which more is paid out will do nothing to improve [Equitable’s] ability to meet policy holders’ expectations: it will not lead to any increase in the fund available for that purpose. Indeed, if anything such a requirement might reduce [Equitable’s] ability to meet those expectations, since it will lead to [Equitable] having less money than it would otherwise and might even precipitate an insolvency. This is why I do not consider that requirements of this sort can be imposed under sections 45(1)(a) and 37(2)(a).

FSA’s Director of GCD thanks Chief Counsel B for providing him with a copy of PIA’s draft mis-selling report and gives his thoughts on PIA’s handling and the report itself. On handling, the Director of GCD writes:

… my main concern is whether there is any need for the report to be maxwellised. Given that it reaches conclusions that the company had engaged in misselling, and that it is to be published, it seems to me that there is a serious issue about maxwellisation. If you agree, it would be sensible to put this in hand as soon as possible, so that it can be complete before the report is needed for publication.

The second handling point relates to the possibility of disciplinary proceedings. I myself [am] particularly concerned about a statement which was made in a letter to all members at a late stage of the court proceedings indicating that the maximum exposure of the society was only £50 million. From memory, the papers I have seen call into question whether this was a sustainable statement at the time it was made. We need to consider it not only from a viewpoint of disciplinary action by the PIA, but also in the context of section 47 of the Financial Services Act. [The Director of Insurance] will be sending a paper to Enforcement on these aspects, so that we are in a position to say what we have in mind to do when this document is published.

On the report, the points of detail made by the Director of GCD include:

• that it might be helpful to ‘deal not only with customers who bought non-GAR policies from the relevant date, but also those who topped them up from that date’;
• that the report should mention that the transitional arrangements for the implementation of the new regulatory regime permited FSA to initiate new disciplinary proceedings against a company on the basis of past contravention;
• that a part of the report is: ‘a key paragraph in indicating that we agree with the conclusion reached by counsel that the Equitable failed, in a generic way, to comply with the disclosure requirements to which it was subject. I think we need to be clear about the status of this finding, given that it is not made in the course of disciplinary proceedings. We need to find a way of expressing this so that it does not appear to prejudge the outcome of any disciplinary proceedings which we may subsequently take, and also so that it does not appear to be reaching a disciplinary decision without proper due process. For example, perhaps we need to make it clear that the conclusion can only be reached without due process in a way that does not prejudice the outcome on any eventual proceedings. But I am not only convinced that this would be adequate and would be glad if you could give it some further thought’; and
• that, as the report concludes that there had been mis-selling up to the date of publication of the House of Lords’ decision, it raised the question of whether there had been mis-selling after that date. The Director of GCD explains: ‘Presumably, this would be the case, because although policyholders would be aware of the decision, they might still not be aware of its potential financial consequences for them. Indeed, as my note indicated earlier, the company may have given them greater reassurance on this point than was properly justifiable’.

Equitable send FSA two documents from their compromise scheme launch pack.

[14:41] FSA’s Head of Actuarial Support says that there were a number of features of these documents that ‘leave me feeling uncomfortable’. He explains:

1)The effect on the balance sheet is likely to be fairly small, given that the value of the new guarantees being offered (to GAR’s and non-GAR’s) appear to be fairly close in value to the provision for GAR’s and the small provision being made for mis-selling costs (though they would of course avoid the potentially larger figure for mis-selling costs could arise in a worst case scenario). Consequently, the supposed advantages (if indeed they exist anyway) of a less restricted bonus and investment policy may not be readily available.

2)It is unclear whether Equitable will be able to pay any guaranteed bonus this year as a result of the low investment returns. They should not be raising expectations of what the scheme can achieve too far.

3)An investment return increased by 1% per annum as a result of the scheme may be rather optimistic, though of course policyholders will not have any clear benchmark to see whether or not this has been achieved (as they will not know what investment policy would have been followed if the scheme were not approved).

4)I do not see how their proposals “ensure” that policyholders electing for 25% cash could buy an annuity that would replace at least 75% of their maximum GAR rights. This must depend inter alia on the current annuity rates at the time of retirement.

5)On a point of detail, the maximum cash for the policyholder in their example would be three times the annuity purchased by the “rest of fund”.

6)The commentary on the other options looks very sparse.

7)In the accompanying letter, are we content for them to write that the Scheme “will be approved by FSA”? Surely, this should say “will need to be approved”.

Finally, all the numbers will of course need to be checked against the latest version of the schema in due course.

FSA’s Legal Adviser E asks Line Manager E what work Equitable were doing to quantify their  mis-selling liabilities, who was doing it and what work they were doing to quantify their future liabilities ‘if there is no 425 scheme’.

[16:44] Line Manager E replies that the ‘actuarial team (which in practice means the appointed actuary, who is a consulting actuary … and the Equitable’s old actuarial department, now part of [Halifax Equitable Clerical Medical]) will be advising the Society on this. They will also be supported by [the Appointed Actuary’s company] who will provide comparative information for other providers and validate the work being done by the Appointed Actuary’. Line Manager E says that he did not believe that the conclusions reached on the liability that existed would be any different if there were no compromise scheme, as Equitable ‘need to work out the liability, and then work out the basis on which it might be compromised and at what price’.

Line Manager E also explains that FSA would see this information as: ‘What Equitable will be doing for its own purposes is to be the subject of a formal requirement imposed under s.44(2B) ICA for an expert review’.

FSA seek advice from Counsel in relation to assessing Equitable’s exposure to mis-selling  claims.

[17:56] In response, Line Manager E says that he and Chief Counsel A thought that it would be useful for him to be aware, and to mention to Counsel, that Equitable’s market value adjuster was not always applied to policy surrenders. The Line Manager explains that this was because of the flexible nature of some of the Society’s policies. Line Manager E says that, because of this, the market value adjuster had only applied to about one third of the £2bn of withdrawals made since December 2000.

The following day [at 14:05], Chief Counsel B says that he would draw this to Counsel’s attention. The Chief Counsel also says: ‘The point about flexibility is that it might materially reduce the costs to Equitable of compensation paid to those who take their benefits early rather than surrender, transfer and suffer an mva’.

Having discussed the issue the previous night, FSA’s Head of Actuarial Support sends Managing  Director A a note outlining his concerns about Equitable’s latest compromise scheme documentation. [12:07] The Managing Director says that he too had ‘a good deal of discomfort’ with the policyholder communication. Focusing on the first point, the Managing Director also concludes:

… that the promised uplifts account for much/all of the Halifax [£250m] + the no longer needed provisions for GARs (say [£1.3bn]) and for misselling. The Society therefore potentially continues after a compromise with less uncertainty about the future but with very little initial room for manoeuvre. (For example a 10% fall in share prices just after the compromise would spark another round of policy value reductions - and such risks need to be spelled out.)

[13:36] The Head of Actuarial Support agrees with the Managing Director’s analysis and expands that there:

… are two separate sets of calculations to look at. First, the Companies Act balance sheet and secondly the effect on bonuses.

For the Companies Act balance sheet, we understand that they had around £1.6 billion free reserves at end-June before making any provision for mis-selling. After the scheme is agreed, the GAR provision of £1.3 billion should be removed, the mis-selling provision should also be removed, and a Halifax contribution of £250 million should be received but instead, there are likely to be additional guarantees given to GAR’s of around £1 billion along with any guarantee that may be offered to non-GAR’s (no details of this have been given to us so far).

Accordingly, I would conclude that the free reserves are still likely to be of a similar magnitude of around £1.5 - £2 billion. As you say, they would still therefore be vulnerable to a fall in equity values if they aim to maintain a significant level of equity investments.

On the second set of calculations, the policy values for GAR’s are likely to be increased by around £1.3 billion, and the policy values of non-GAR’s by around £700 million (assuming a 4-5% uplift) as a result of the scheme. This will be funded by the removal of the £1.3 billion provision for GAR’s and the Halifax contribution of £250 million, leaving a potential shortfall of up to around £500 million. It is not clear to me whether they have sufficient margins available to fund this without making a further small cut in bonuses for everyone.

In any event, I am not sure how acceptable the scheme will be if Equitable reserve the right to remove the uplifts (on a proportionate basis of course for everyone) at any time in the future.

HMT send FSA a copy of the report regarding the Civil Service pension scheme.

[11:57] FSA’s Managing Director A gives his immediate reaction to the report, saying that:

a) it is somewhat less alarmist than HMT originally implied but pretty gloomy for all that;

b) we are clearly likely to get drawn into a row about transparency over the terms of bulk surrenders. Personally I have every sympathy with those who think that there should be transparency in the process by which surrender values are calculated. perhaps we could put this on the agenda for the next evening “wrap-up” meeting.

FSA issue Equitable with a Notice pursuant to section 44 of ICA 1982 requiring the Society to instruct the Appointed Actuary’s company to assess possible mis-selling liabilities. FSA explain that they:

… had intended to instruct another firm to carry out work in relation to such possible misselling. The Society will, naturally, be carrying out its own estimation of such potential liabilities and will, I assume, be supported in this by the Appointed Actuary and staff from his firm … The FSA will also need to have sufficiently detailed information to form its own assessment of the possible liabilities.

In order that there is no duplication of effort and undue disruption to the Society’s work towards a compromise scheme, I am writing to require the Society to further instruct [the Appointed Actuary’s company] to address the estimation of possible misselling liabilities on, at least, the assumptions which the FSA will need to evaluate. You may wish to evaluate other bases yourself or with [the company’s] help.

FSA continue:

We are not asking that [the Appointed Actuary’s company] form a view as to whether misselling has occurred or, if it has, what the basis of compensation should be. Rather, we are providing a range of assumptions to be made, and are asking only that [the company] carry out the computations necessary to quantify possible liabilities on these assumptions. We then need [the Appointed Actuary’s company] to provide the FSA with details of these computations in sufficient detail that we can review them, understand how they are derived and overlay our own analysis as legal opinions develop.

Equitable’s Appointed Actuary writes to FSA’s Head of Actuarial Support about the reinsurance treaty and, in particular, the issue of the renegotiation clause if claims reached £100m, the issue having been raised by the Society’s new auditors. The Appointed Actuary says:

From the Society’s point of view I believe that the attached extracts show that the matter was discussed with you, changes made, the final Treaty sent to you, and the Treaty used for 1998, 1999 and 2000 Returns.

The purpose of this letter is therefore to ask you to confirm for the benefit of myself as new Appointed Actuary and … the Auditors, that the attached describes the position from your point of view and that you have nothing to add.

The Appointed Actuary encloses a note, dated 2 August 2001, from a former Appointed Actuary to which he attaches four documents, with the following description:

A – The relevant extract from the draft treaty submitted to FSA/GAD in advance of a meeting held on 28.1.99 plus the relevant notes from that meeting. Those notes show the people present and at 8 record the views which FSA/GAD expressed on the clause in question.

B – Copy of our note of 1.2.99 to [IRECO] requesting the various changes indicated by FSA/GAD (point 3 deals with the clause in question) together with our suggested rewording of the clause.

C – Relevant extract from the updated treaty submitted to FSA/GAD in advance of a further meeting on 19.2.99. This is unchanged from what we had suggested to [IRECO] in B above and was not discussed further at the 19.2.99 meeting.

D – Letter dated 22.2.99 from [Head of Actuarial Support] recording the points they had asked us to negotiate on further at the 19.2.99 meeting. You will note that the £100m renegotiation point clause is not mentioned as a matter needing further attention and the statement on page 2 confirming that, subject to the specific points mentioned, the treaty would have the intended reserving effect.

In the note, the former Appointed Actuary says that he thought:

… it is also pertinent to remember that no query was raised in connection with the credit taken for the treaty in either the 1998 or 1999 returns and I assume the same is also true for the 2000 returns.

FSA host a conference call with Equitable. According to FSA’s note of the call, the following issues were discussed.

Equitable’s Chairman said that he was spending a significant proportion of his time dealing with the press, whose focus was on what would happen if the compromise scheme failed. FSA record that he:

… continued to emphasise that the Board had not considered this, but were focussing solely on getting the compromise scheme to work. He was however concerned that the compromise scheme could be defeated by GAR policyholders, in value rather than number. He was clear that if this scenario materialised the Society would be in a severe state of instability and the govt would come under renewed pressure to intervene.

It is noted that press attention had not ‘majored’ on the review of Equitable’s financial position.

On Equitable’s solvency position:

[FSA’s Managing Director A] noted that the FSA continued to adopt a cautious line on the Society’s solvency position and pointed to the fundamental uncertainties referred to in the annual report. [Equitable’s Chairman’s] line was that he was happy the Society was, and will continue to be solvent. He noted that he refers to the fact that ELAS remains in close contact with the FSA and this appears to provide some reassurance. [FSA’s Director of Insurance] noted that the FSA could not adopt a more positive stance as we had not yet seen the figures on which ELAS were basing their statements. [The Chairman] said that the FSA should do whatever they can to reassure themselves – if information was required to verify the Society’s stated position, the FSA should not hesitate to request it.

The timing of the publication of Counsels’ opinion and the compromise scheme are discussed, along with progress on that scheme.

Equitable’s Chairman acknowledges that relations between the company and Halifax ‘could be closer and better’.

FSA note that they were aware that the Appointed Actuary’s company were advising public sector schemes to ‘get out wherever possible’ and that this was likely to hit the press within the next few days. FSA suggest that Equitable should be ready to publish figures on outflows from the with-profits fund if, for example, the adviser’s report caused concerns. Equitable’s Chief Executive acknowledges FSA’s view, ‘although the outflow figure was higher than he would like to have to announce’.

FSA talk to Equitable about the proposals for dealing with Counsel’s opinions and claims for  mis-selling within the compromise scheme. Line Manager E circulates a note of the discussion the following day. The Line Manager records that Equitable’s initial thinking had been to:

… follow their approach to buying out the GAR, namely follow a two stage process that first identified the overall loss (ie the aggregate cost to the Society of meeting claims) and then devise a mechanism for sharing that amount among qualifying policyholders.

In terms of the aggregate cost, they were coming to the view that the loss was the effective reduction in policy values from the suspension of bonus for 7 months in 2000 to pay for the House of Lords, which in effect reduced policy values by 4.7%. There was also a cut in reversionary bonus as they estimate, had it not been for the [House of Lords’] judgment, they would have applied a reversionary bonus 4% higher for 2000. In fact this amount has to be adjusted for some policies because policies between 1988 and 1996 have a 3.5% income guarantee and have already received the bulk of their 4%, and so would be compensated at a lower level.

In terms of the amount allocated as compensation to individuals, they thought there were two possible ways forward. One was to have a points system so that they could assess the different basis of claims against the society and weight the claims depending on the chances of success and the likely form of damages. They could then allocate points to each policyholder to reflect the claims that they would have and allocate the compensation according to individual scores. The alternative was a less scientific approach that would work on the basis that either a person had the basis for a claim or they did not, and make no distinction between the basis of the claim (or its value or probability of success). I got the impression that they are inclined to favour the latter since it is easier to understand and arguably no less fair that the more sophisticated approach which could have the effect of compensating a person for the same loss several times over because of the number of bases on which they could bring a claim.

They are of the view that the compensation cost is additional, and therefore a charge on the with-profits fund as a whole (and ranks ahead of any “liability” to pay discretionary benefits.) As it is a charge against the fund as a whole, this means it has effectively to be met by all policyholders, and therefore is paid for substantially by the non-GARs.

Line Manager E goes on to comment that this:

… raises an issue that is largely presentation, but quite critical in terms of handling. Namely, should the cost be covered by making a transparent cut in policy values to free up sufficient assets to cover the compensation costs to non-GARs (and if so should that be done before or as part of the scheme); or should the amount of uplift of GARs and non-GARs be scaled back to put them in the position they would have ended up in had they been put through each stage of the adjustment. In other words, should they be offered (say) a 20% and 4% up lift for GAR and non-GAR policyholders respectively, with policy values simultaneously being cut back by 3%, or should the uplift simply be reduced to say 15% and 1% (with an explanation as to why those are the right numbers).

The Line Manager adds that FSA:

… also need to think about this point from a technical viewpoint because it may be that there are situations where the iterative approach to calculating revised policy values would produce a different outcome to the application of a simple uplift factor. For example, it may vary depending on the extent to which a policy value includes enough terminal bonus to cover the “loss” in value.

FSA’s Legal Adviser E provides a note on whether group scheme policyholders should receive  the same benefits under the Policyholders Protection Act 1975 as any other policyholder. The Legal Adviser concludes that such group scheme policyholders should do so.

[18:58] Legal Adviser C agrees and confirms that it was the same under the Financial Services Compensation Scheme rules.

In response to Line Manager E’s note of the meeting held the previous day with Equitable, FSA’s Managing Director A comments that, on handling, Equitable would be ‘crazy to go for the first of the 2 options you describe (the transparent one)’. The Managing Director notes, however, that ‘whatever they do the furore will surely be about the assumption that this is a charge off the top and that therefore the non-GARs end up paying for most of it, despite the fact that the source of the loss comes from GARs getting a bigger slice of the pie, largely at the non-GARs expense in the original [House of Lords] judgment’. The Managing Director asks officials to think hard about the rationale for this and whether FSA ‘buy it’.

[13:26] Chief Counsel B advises that FSA’s shared legal view was that any mis-selling compensation was a charge to be borne by all with-profits policyholders ‘with the result that Non Gars as a class bear a substantial part of the misselling costs’.

[13:31] The Head of Insurance Policy queries whether ‘it is only under the [Counsel for FSA’s basis] that non-GAR’s in effect pay for most of their own compensation. Under [the Society’s Counsel’s basis] the compensation is to top up the Equitable policy values so that they equal the industry average. If payment of the compensation itself reduces the policy values this in turn means that the amount of compensation must increase. The total amount that non-GAR policyholders receive remains constant (equal to the industry average). It is merely the split between policy value and compensation which changes’.

[13:36] The Head of Actuarial Support suggests that there was an issue that needs to be discussed. He explains that:

The effect of their proposal is that non-GAR’s will be offered a net uplift of only around 1-1.5% of their policy value and will therefore still be around 3-4% worse off than if  the GAR problem had not arisen (largely as a result of the non-GAR’s representing around 75-80% of all the policies by value and therefore having to meet the bulk of  all the costs).

An alternative would be to offer the non-GAR’s a 4-5% net uplift but this would result in the GAR’s having to take a cut of around 15% in their policy values which is unlikely to be palatable. There may of course be other intermediate offers that could be made between these two positions.

[15:28] Chief Counsel B explains that he thinks that ‘the approach is the same for [the FSA’s Counsel’s opinion] and [the Society’s Counsel’s opinion] – to the extent that both support claims for damages based upon a tort (inadequate disclosure (s62); misrepresentation; negligent misrepresentation). The position would be different if the claims were contractual in nature and Equitable acted to give effect to what would be enhanced policy rights and values’.

[15:56] The Head of Actuarial Support says that he was:

… a little puzzled by this. Does this mean that the possible basis of redress mentioned by [Chief Counsel A] whereby Equitable is asked to guarantee to provide benefits in future at the average industry level for a comparable policy, is no longer required?

Incidentally, I believe that as part of the pensions mis-selling review, we did allow some insurers to provide redress by way of a guarantee that they would be no worse off than if they had remained a member of their previous occupational pension scheme. Perhaps, though, there was deemed to be some form of contractual warranty involved?

[21:18] The Head of Prudential Policy asks Chief Counsel B to confirm that ‘under [the Counsel for Equitable’s opinion] non-GAR policyholders would not effectively be placed in the same position they would have been in had they effected a policy with another insurer (industry average) instead of Equitable?’

PIA write to FSA in response to discussion earlier that day about advice provided by  independent financial advisers. PIA send them the question and answer briefing prepared  on 27/07/2001 [15:44] and ask FSA to consider if they had now decided to elaborate on the guidance previously given. PIA say that they agreed with FSA that independent financial advisers were looking for more information but note that ‘feedback from the consumer helpline indicated that many [Independent Financial Advisers] were reluctant to give advice’.

[16:37] FSA clarify that:

1) I’m not suggesting that we necessarily put anything new out to [Independent Financial Advisers] and if you are not getting that many calls that seems to argue against putting anything new out.

2) The text you’ve got below looks OK to me but there is a quite separate worry that [Independent Financial Advisers] have been expressing and I’d like us to agree a line on that too. The worry is that where an [Independent Financial Adviser] doesn’t want to give advice that we will somehow insist or discipline them for not giving advice. I presume our answer to this is “Where an [Independent Financial Adviser] feels that they lack sufficient information on the Equitable to be comfortable giving advice they should make that clear to their client” …

FSA meet Equitable for a weekly round-up. FSA’s note of the meeting includes the following.

Reporting requirements

It is noted that the independent review by reporting accountants of Equitable’s financial position was under way but that the review by actuaries to assess the potential mis-selling liabilities would now proceed on a different basis, as neither FSA or Equitable had been successful in appointing someone to do the work.

On the regular financial reporting requested by FSA, Equitable ‘expressed some concerns … because he thought the Society did not have all the information that we were asking for’. The issue is discussed further and it was established that the reporting could largely be provided in the format requested. FSA record that they: ‘did not propose to make that subject to a formal notice of requirements. This would give us greater flexibility to update the form and content of the information to reflect concerns at any particular time’.

Compromise scheme

Equitable provide an update on the compromise scheme following a meeting of their steering group the previous day.

Equitable’s Chief Executive also mentions that they would be seeking FSA’s consent to buy back up to 10% of the subordinated loan and says that he thought that ‘following the interest payment and the recent announcement, the earlier difficulties had largely gone away’.

Chief Counsel B answers the FSA’s Head of Prudential Policy’s question of the previous day, confirming that:

1. No, the particular distinction between [Counsel for Equitable] and [Counsel for FSA] (there are others of course) is that they part company on the extent of the recoverable loss. [The Society’s Counsel] says all the consequential loss is recoverable including loss attributable to poorer investment performance. [Counsel for FSA] is prepared to apply a more restricted approach (although he concedes that on the facts an investor who was positively advised to take out an endowment policy may be entitled to damages on the potentially more generous basis – actually I suspect most Equitable policyholders purchased on advice given by a sales representative – this is something I consider I need to mention to counsel, we did not accept an argument from the Equitable and others in the context of the pensions review that policies had merely been sold in response to the provision of “information”.

2. To the extent that the Society has incurred a civil liability to compensate for tort, this is a liability of the Society generally and is to be met out of the Society’s assets.

FSA’s Head of Actuarial Support replies to Equitable’s Appointed Actuary’s letter of  07/08/2001, saying that:

Our understanding of this paragraph is that the treaty would not be cancelled but that negotiations would take place with the aim of restructuring the treaty in a mutually agreeable manner. In particular, the “Adjustment Premium” would be redefined in respect of future years. However, our understanding from these meetings in early 1999 was that Equitable would not agree, and could not be forced to agree, to a restructuring that had a materially adverse effect on the value of the reinsurance offset that could be included in the FSA returns. You have no doubt come to a view yourself and if differs materially from ours, I would be grateful if you would let me know.

HMT’s Director of Financial Regulation and Industry updates the Economic Secretary to the  Treasury on Equitable in relation to: administration and Article 4; advice on response to the Treasury Select Committee; a possible Government statement; and dealing with related correspondence.

The Director notes that the delay in publication of Counsel’s opinion ‘potentially provides a bit more time/expands the range of options for announcing an enquiry’.

FSA’s Chief Counsel B sends officials a note (dated 10/08/2001) on Article 4 of Equitable’s  Articles of Association and where FSA should go now. The suggested ways forward are:

a) Continue to ask HMT to make changes to relevant subordinate legislation pointing out in particular the scope which exists for the [Policyholders Protection Board and the Financial Services Compensation Scheme] to be seized of a matter even without a formal decision on whether the company is solvent

b) Carry out preparation necessary for a possible judicial review application of [the Policyholders Protection Board] – particularly locus for FSA to bring an application and how we might otherwise sponsor an application by an affected policyholder.

c) Proceed with proposed changes to [the Financial Services Compensation Scheme] Rules on the basis that this ought to mitigate the problem post N2 but acknowledging that the rule might fall away in the face of a contrary ruling by the court.

d) Develop further the scenario planning for how the Article 4 point might best be resolved by the Court in the context of insolvency proceeding.

FSA’s files include an internal Equitable paper, dated 10 August 2001, entitled ‘Mis-selling and the S425 Scheme’. On this, an official has written that it had been received from Equitable on 13 August 2001. By way of introduction, the paper explained that:

[Counsel] has opined (although only in draft form at present) that at least some categories of non-GAR policies have a strong claim for mis-selling. This increases the uncertainty as to the future financial position of the Society and individual with-profits policyholders. GAR policyholders are uncertain as to the total cost they may have to bear in the future for mis-selling compensation claims to non-GARs, and the non-GARs are uncertain as to the likelihood of success of any individual claims they may bring and the timescale in which they might receive any compensation due.

As the main driving force for undertaking a S425 scheme was to bring back a level of certainty to the Society’s with-profits fund, it seems necessary to consider how the uncertainty brought about by [Counsel’s] opinion can be factored into the current plans for a compromise scheme between GAR and non-GAR policyholders.

Equitable say that the main options to solve the problem were:

• Mis-selling claims are dealt with on an individual basis either through the Courts, by bilateral agreement or through an Ombudsman.
• The FSA may instigate a review on an individual policy basis of a similar nature to that used for personal pensions mis-selling.
• Undertake a second S425 compromise scheme for mis-selling of non-GAR policies.
• Incorporate mis-selling of non-GAR policies in the current S425 scheme.

In both of the last two options the non-GARs would be offered compensation for giving up their legal rights to pursue a mis-selling claim.

The paper then sets out the appraisal methodology used; an appraisal of the main options; conclusion of the main options; and the ways that mis-selling claims could be included in the existing compromise scheme proposals. In conclusion, the recommendation was that the best way forward would be to bring mis-selling claims within the GAR compromise scheme.

FSA’s Head of Life Insurance seeks advice on how to respond to an invitation from the Institute of Actuaries to give evidence to their Investigating Committee, who were looking into a complaint of alleged misconduct against a former Chief Executive of Equitable.

[10:28] Managing Director A comments that FSA’s Chairman most definitely wanted to leave open the possibility of FSA taking action against previous Equitable officers.

Chief Counsel B circulates some further thoughts on the Article 4 issue, after having been  shown a professional paper (‘Review of the Law Relating to Insolvent Life Insurance Companies and Proposals for Reform’, dated January 1984) presented to the Institute of Actuaries.

[21:56] The Head of Insurance Policy says that he suspected that the paper was not accurate and sets out what he understood to be the correct historical context for Article 4.

Following discussion the previous day, the Director of Insurance writes to FSA’s Director of  Regulatory Strategy and Risk setting out what he believed to be the potential enforcement issues arising from the Equitable case. On FSA’s powers under ICA 1982, the Director of Insurance writes that the Act:

… is generally directed more at the maintenance of prudential standards and does not generally provide for action against individuals or companies except for the purpose of safeguarding policyholders or potential policyholders (in other words it does not generally provide an apt remedy in relation to past events except where this is appropriate to protect present and future policyholders). The most likely avenues would appear to be:

a) “Fit and proper” action – but note this is only available against people who occupy, or who propose to take “notifiable” positions.

b) The Insurance Companies Act makes a number of actions and failures criminal offences (and the directors may be held criminally liable for offences committed by an insurance company). The most relevant are likely to be in relation to the submission of regulatory returns between 1988 and 97 with inadequate disclosure of the contingent liability represented by the GAR policies. The relevant prosecution authority is HMT. I am not aware of any prosecution of this sort and I think this possibility should be regarded as theoretical.

The Director says that it seemed to him that:

… [FSA’s] next steps on the Equitable should be determined by references to our statutory objectives and our aim should be to select the optimum mix of tools to address these. Our focus thus far has been very heavily towards the prudential issues and mitigating risk of loss to policyholders by close monitoring of the Society’s financial position; by working to ensure that a failure, if one occurs, can be handled in such a way as to cause least disruption to payments and that appropriate compensation is available; and working with the Society to ensure that the scheme of arrangement which it intends to put to policyholders represents a better option for them than the alternative and is fair as between different groups of policyholders. Intervention Action, under Insurance Companies Act powers (which given the profile of the case would need to be approved by HMT Ministers) is planned, on a contingency basis, to require the Society to handle this process in an orderly way. Enforcement action, particularly in the form of disciplinary action against culpable individuals might, on further enquiry, prove to be appropriate, although (it seems to me at least) is likely to be a secondary issue as compared with our main prudential objectives. Nonetheless it must be right to consider the full range of tools, available to us.

FSA meet to discuss their views on Equitable’s compromise scheme proposals. Line Manager E’s note (dated 16 August 2001 and including comments by Chief Counsel A) includes the following record of the discussion. By way of introduction, the Line Manager explains that FSA’s:

… discussion was on the basis of the information provided so far, and subject to further supporting material being provided in due course. It was also in the knowledge that a further layer of compromise has to be built on top of the GAR scheme. We did not seek to reach a view on that (other than that it was unthinkable that the GAR scheme could feasibly go ahead without it once [the opinion of either or both of Counsel for the Society or the FSA] had been published). The net effect the second part scheme will be to scale back the compensation under the GAR/non-GAR part, but this will happen proportionately and so does not affect the analysis of the GAR/non-GAR component. (Once the legal opinions are published, absent a scheme, effectively the value of policies would have to be scaled back which would reduce the value of the GAR rights by an amount that corresponds to the adjustment that would have to made to the uplift under the scheme.)

Our consideration, consistent with the draft criteria letter, was on the two components of the GAR scheme – the method for determining the aggregate amount of money available to buy out the GAR rights and the methodology for distributing that pot among the GAR policyholders.

On ‘The size of the pot’, FSA say that Equitable’s proposal (for a ‘pot’ based on the current best estimate of the cost of providing annuities at the guaranteed rates specified in the policy) was ‘arguably a perfectly reasonable and justifiable approach to setting the pot since in a sense it reflects the current costs of the GARs to the non-GARs’. FSA note that work was being undertaken by both FSA and Equitable on an alternative approach, which would look at the value that the annuity guarantees would have on the open market. The note goes on to record that:

One of our proposed criteria was that the value being paid was a fair value for the rights being given up. It is not proposed by Equitable Life or the FSA that the transaction should result in one side making a profit at the expense of the other. It seems to us that an amount higher than that derived by either of these methodologies would advantage GAR policyholders to the detriment of non-GARS; and a lower value would unfairly advantage the non-GARs. This view was subject though to fairness being achieved in the division of the pot …

FSA note that their second criterion of ‘Dividing the pot’, ‘addressed the fair distribution of the pot to policyholders so that individual groups would not suffer a material detriment (or increase) compared with the rest’. FSA record:

There has always been a presumption, that we have never challenged, that the GARs would be bought out in exchange for an uplift in policy value. The idea of some other mechanism, such as the offer of a windfall single cash payment, has never been seriously considered. The proposition is that the uplift would operate on both the guaranteed and non-guaranteed amounts. This would appear a logical position to reach since if all the uplift were added to the guaranteed amount, it would not achieve the wider objective of the scheme of releasing statutory reserves and stabilising the fund. It is my understanding that we all accept that approach.

The key factors that have been identified in placing a value on the rights of individual GAR policyholders are:

a) policy value;

b) the type of policy;

c) age;

d) time to retirement;

e) sex;

f) marital status;

g) whether they will take tax free cash; and

h) whether or not they are paying (or can pay) future premiums.

I do not believe that we have identified further factors that need to be considered, nor subject to the issue on future premiums, do we object to the approach they have taken.

FSA then examine the detail of each of the key factors. In conclusion, they say that they: ‘will wish to undertake further verification of the information on which this assessment is based. We also wish to resolve the subsidiary issue of future premiums. Any conclusions on the acceptability of the GAR scheme will also depend on progress on the mis-selling scheme and the review of financial data. However, in principle, I believe those of us present at the meeting have concluded that we do not object to the proposals put to us’.

The Economic Secretary to the Treasury holds a meeting about Equitable. The action points  from the meeting include issues in relation to the establishment of the Penrose Inquiry and ‘[administration] v [provisional liquidation] v winding up etc’. On the latter, the action points are:

a) [The Economic Secretary to the Treasury] would like categorical advice from the FSA on the admin v provisional liquidation issue in the form of a submission with a firm recommendation (not an exchange of letters) …

b) [The Economic Secretary to the Treasury] understands that it is now hoped that [Equitable] will remain solvent but would like to see a grid that compares the various other scenarios for the future of [Equitable] including

• administration
• provisional liquidation
• full liquidation
• voluntary winding up
• compulsory winding up

and draws out the implications for policy holders under each scenario including:–

1. likely impact on policy values, any distributional effects, and any Article 4 issues
2. likelihood of continued pension/annuity payments to policyholders in [solvent run-off], interim and long term
3. the likelihood of a successful Halifax deal
4. the [Policyholders Protection Board’s/Investors Compensation Scheme’s] commitments to pay compensation (90% of what?)
5. likely calls for Govt compensation
6. likely calls for any other Government action (eg tax angles)

c) HMT to seek the views of Halifax and the [Equitable] itself on which of the above options they would favour. Also to ask [Equitable’s] own interpretation of Article 4. [The Economic Secretary to the Treasury] to see FSA’s latest advice on article 4.

d)[The Economic Secretary to the Treasury] would be grateful for further advice on whether there are any downside risks to putting a generalised consultation document on the administration order out soon ahead of [the publication of the opinions of Counsel for Equitable and Counsel for FSA] (as part of a package of other [FSMA 2000] orders).

HMT’s Director of Financial Regulation and Industry asks two HMT officials what the Policyholders Protection Board would pay in the event of insolvency. The Director explains his reason for asking:

… is that in my simple minded way I said to myself:

• the question of insolvency revolves around whether the society has assets to cover 100% of its liabilities, plus the regulatory margin. Liabilities would need to rise further by over 10% therefore, or assets fall further by over 10% (ie c £2.5bn plus the size of the margin), compared to the changes needed to trigger insolvency, for the 90% threshold to be passed. ie insolvency (were it to occur) would be unlikely to be so bad as to trigger [Policyholders Protection Board], or [if an insolvency occurred after the new regulatory regime had come into force, Financial Services Compensation Scheme], payments.

HMT forward their query on what the Policyholders Protection Board would pay to FSA.

[09:58] FSA set out their understanding of the position, which was as follows:

The 90 per cent is (and I paraphrase given that the precise wording in the [Policyholders Protection Act] 1975 may be different in any event from the future [the Financial Services Compensation Scheme] rules) the percentage of the benefits that would be paid based on the value of the contract at the time of the winding up, determined in accordance with the insurance company winding up rules (which will have to be remade by the Treasury with the DTI’s consent under [FSMA 2000]).

The interpretation of the relevant provisions has not been fully tested. We believe in the case of eg an endowment it would be based on the current guaranteed value of the policy. In the case of a pension fund, it would probably be the same (ie on the basis of the guaranteed fund) except that in the case of a pension plan that provided a GAR, the liability that would have to be met would be the annuity at a guaranteed rate at the future point on the basis of a guaranteed fund, which would therefore translate into an obligation to provide (or fund) an annuity which provide 90% of the benefits that would have been payable on the basis of the GAR that could be purchased with the guaranteed fund. We would expect an annuitant in payment to get 90% of their income.

There are however (or so I believe) references in the regulations to [expectations] of policyholders. That may not mean that policyholders are automatically entitled to receive their full share of terminal bonus, but it may be that they can claim for more than the guaranteed amounts referred to above. So the position is not entirely clear.

Compensation for mis-selling payable pursuant to section 62 of the FS Act 1986 is not a contractual right under the policy and would not therefore be compensated by the [Policyholders Protection Board]. It would instead fall to either the PIA indemnity scheme or the [Investors Compensation Scheme] (but I am not entirely sure which of the two). The normal payout rules would apply (90 per cent up to the relevant caps).

Solvency can be defined in a number of ways. For the insolvency act purposes, terminal bonus which is not guaranteed is not taken into account, so the trigger is at a lower level then aggregate policy values. The solvency margin is relevant to our supervisory arrangements and its breach provides a trigger for intervention powers. However, it is not relevant for determining whether a company is solvent in a company law sense. [ie an insolvent insurer would already have gone through the solvency margin. NB. The companies act and ICA valuations are done on different bases anyway, so you cannot compare insolvency and regulatory concepts directly.] In addition, although slipping below the 100 per cent may in theory mean there will be plenty of money left and could well cover more than 90 per cent of the policy values, in practice that will probably not happen because i) lots of money gets taken up by the insolvency practitioners, ii) non-cash assets could have to be disposed of at distressed prices and therefore below book value and iii) certain [liabilities] (eg the GAR rights) will increase in value since they would be valued on the basis of 100 per cent take up rather than the current 60 per cent.

Equitable write to FSA in response to various letters. First, in response to FSA’s letter of  10/08/2001, Equitable confirm that they expected to be able to give the Appointed Actuary’s company all of the information requested to enable them to meet FSA’s deadline for the reviews.

In response to FSA’s letter of 31/07/2001, Equitable provide a report of the Society’s financial position under a Companies Act basis, as at 30 June 2001. Equitable also enclose the proposed format for the monthly reporting of its financial position and weekly reporting on the processing of claims.

In response to FSA’s letter of 13/08/2001, Equitable say that the Society’s Chief Executive would reply more completely to this.

Equitable also repeat their concerns about the compromise scheme that ‘the sign-off process for the FSA is very unclear to us and that there seem to be many parties involved who appear to revisit issues which on occasion we thought had been closed’. Equitable also complain that there were multiple points of contact with FSA and ask them to nominate a project co-ordinator.

FSA’s Head of Life Insurance prepares a list of what he saw as the potential ‘show-stoppers’ to  the compromise scheme, which he sets out in the form of a draft letter to Equitable. Having received comments, the letter is revised and handed over to Equitable at the meeting later that day. The Head of Life Insurance’s letter reads:

1.… the FSA is not yet in a position to take a view on the proposed Section 425. However, we agreed that it would be useful if I could set out for you, on the basis of our present understanding, what we at working level see as outstanding issues, and the weight we attach to them (without prejudice to FSA’s final view).

2.I start from the proposition that before the Equitable announce any proposals for a scheme, it needs some reassurance from FSA that we see no “show stoppers” (that is to say, any aspects which are so significant that our inability to support them (or at least indicate no objection) would be fatal to the success of the scheme).

3.At present, there are a number of aspects on which we do not have enough information to give that kind of assurance. These are:

3.1.The treatment of mis-selling liability. This covers:

(a)The legal basis for assessing liability (in the light of [the opinions of Counsel for Equitable and for FSA]);

(b)The method of quantification (in the light of the work being done by [Equitable’s Appointed Actuary and his company]).

3.2.The financial position of the Equitable, where we should want to see the results of the work commissioned from [the Appointed Actuary’s company].

4.As regard the GAR/non-GAR element of the scheme, we have asked for extra information, which we shall need before we can take a considered view; but this relates to aspects which we do not anticipate will give us significant difficulty provided that the information which we have asked for does not contradict or undermine the approach which Equitable has set out in its Business Case. We have already asked for some work on financial option theory to test the justification for the cost based approach to assessing the aggregate amount to be made available to buy out the GAR rights; and we have asked for some additional figures to show the effects of the scheme on holders of flexible GAR policies (equivalent to the information supplied in respect of retirement annuity holders at a meeting with [Equitable’s] team on 13th August).

5.A further point to flag up at this stage is that the latest version of the Business Case appears not to deal with the distinction between premium and non-premium paying policyholders. This issue is I think linked to the question of whether or not you cease to apply the GAR to top-ups (after due notice). We need to understand what approach you are taking, and why. More specifically, we note that a substantial number of policyholders can no longer make top-ups (for example under the tax rules which prevent top-ups if self-employment has ceased). It is not clear why this group should receive compensation for giving up the ability to make top-ups.

FSA meet Equitable for a weekly review. FSA’s note of the meeting records discussion of the following issues:

Compromise scheme

Equitable’s Chief Executive says that he had become increasingly concerned about Equitable’s lack of project management and that many of the delays experienced were due to Halifax Equitable Clerical Medical. FSA’s Director of Insurance notes ‘we were on the same side in that we both wanted to find a solution to the Society’s current difficulties’ and that FSA had formalised their requests in response to the concerns expressed by them (see 15/08/2001 [10:33]).

Mis-selling

Equitable report that they had raised with Counsel a question about their original instructions (namely, that those instructions had suggested that Counsel should take certain unproven facts as given when providing his advice. This had had the effect that any mis-selling, if it had happened, had done so from 1988) and that he had requested further information. The Director of Insurance notes that, while the proposed compromise scheme was effectively an out of court settlement:

… the mis-selling elements were also of direct relevance to the FSA’s role since they related to a possible breach of Lautro (and so PIA) rules. The fact that the FSA had powers to require a process for giving redress meant that we also needed to be satisfied that the offer being made was a fair one.

Possible legal action against former Equitable directors and auditors and the regulators

Equitable say that their solicitors were still considering the position.

Premium paying/paid up policyholders

FSA ask why the compromise proposals included compensation to policyholders for giving up rights to pay further premiums, an option which in some cases they did not have. Equitable say that they would look into the issue.

Subordinated debt

FSA say that they had been unable to take a view on the proposal that Equitable should buy back some of the subordinated loan until more progress had been made on the independent reviews on the Society’s financial position and on mis-selling. Equitable express regret at this, as they believed it would be in policyholders’ interests to buy back the debt while the market price was favourable.

HMT’s Director of Financial Regulation and Industry speaks to Halifax ‘primarily to say lines are open which he welcomed’. Halifax say that they would prefer administration to provisional liquidation and raise a concern that Equitable’s public relations efforts were poor and that they needed to get ‘more “pace and grit” into the timetable and confront policyholders with a “stark choice” over the future. Hmm’.

[17:27] The Director also speaks to Equitable’s Chief Executive. He records, among other things, that ‘On insolvency he was confident; only litigation could make [Equitable] insolvent in companies act terms; he was also pretty confident they could meet the regulatory margin requirements although a fall in markets would pose risks’.

Equitable send FSA three documents for the compromise scheme launch pack, being:

‘Consultation Document’; ‘Background to the Compromise Agreement’; and a letter to policyholders.

[14:00] Line Manager E circulates the papers and suggests discussing them at their end of day meeting.

[17:00] An official says that the letter to policyholders needed amendments as it was too long and ‘does not even begin to address the policy holders needs as in “what’s in it for me”’. The official also says that more emphasis on the effect on policyholders, as opposed to the benefits to Equitable, would be desirable.

[18:36] The Head of Actuarial Support comments on some points of detail.

Line Manager E sends round the notes of the meeting on 14/08/2001 and asks the Director of  Insurance and Managing Director A for their views on the conclusions and on how to take the matter forward.

[22:17] Chief Counsel A says that she was happy with the broad structure and the ‘bottom line’ but suggests that they should meet the following day to discuss.

FSA’s Managing Director A provides FSA’s Chairman and Managing Director B with a state of  play report on Equitable before going on leave. Managing Director A begins by saying:

Other than the Equitable, there isn’t much to report, you’ll be pleased to know that can’t await your coming in/other contacts. [FSA’s Director of Regulatory Strategy and Risk] is struggling manfully with [an insurance company]; Argentina continues to hover on the edge; markets are weak but not yet (at time of writing I hasten to add as things are volatile!) at new lows.

The Managing Director sets out the overall picture and progress on Counsel for Equitable’s opinion and on the compromise scheme. The progress report says that FSA:

… have had some quite hot debates with Equitable over presentation. However you cut it, there is no new money (other than the Halifax £250 mn). Equitable’s likely offer has touches of Alice-in-Wonderland (everyone gets “prizes” in the form of some sort of uplift). And this will be seen through very quickly. We have therefore urged Equitable not to oversell the results of a vote in favour. In particular, the Scheme will not produce sizeable free reserves and will not immediately restore full freedom of investment (though it will, of course, remove the constraint imposed by the current uncapped GAR liabilities). Rather, it seems to me, successful completion of the Scheme is bound to be followed by a period of relatively cautious investment policy ([on account of] lack of free reserves) and the desire to build up reserves through a careful bonus policy. Originally, the Society were describing the benefits of a vote in favour in glowing terms but more recently have become more circumspect.

On Equitable’s solvency position, the Managing Director reports that there had been no signs yet of problems but he suggests that FSA’s Chairman and Managing Director B would ‘want to press hard on at least 2 issues, even if there appears to be a relatively clean bill of health’. These were:

Any positive value ascribed to implicit future profits. (Even on the most positive scenario, the business will contract rapidly and we know that, to the extent people get out without paying an MVA they are not paying an up-front sum that could be regarded as making good the loss of future profits on this business.)

Our old friend reinsurance. There appears to be something in the current arrangements that require a mutually acceptable renegotiation of the reinsurance contract if payments under it get to £100mn. Any reliance [the Appointed Actuary’s company] place on this reinsurance has got to be fully realistic.

Managing Director A says that the work on estimating potential mis-selling liabilities had gone more slowly than desired and he explains the current position on possible FSA guidance on mis-selling.

Under ‘Enforcement’, the Managing Director says:

We believe (but Equitable won’t confirm) that [solicitors] have advised Equitable that they can go after at least some past Officers and Directors. Equitable intend to cover that with the other material they put out.

For our part, [the Director of Regulatory Strategy and Risk] has been talking to Enforcement about what we might do – things are made more difficult here by the fact that [three Enforcement Heads of Departments] all have substantial exposure to Equitable and will wish to rule themselves out. A note from [the Director of Insurance] is attached at Annex 5 but, [Chairman], you will need to give direction to this on return.

The Managing Director reports on FSA’s discussions with HMT regarding ‘gagging’ Equitable from publishing their Counsel’s opinion on mis-selling claims; the merits of administration and provisional liquidation; and the correct interpretation of Article 4 of Equitable’s Articles of Association. He says:

HMT are clearly expecting options in this whole area to be put to the [Economic Secretary to the Treasury] for resolution… However much this jars, given their powers to help or hinder and the risks if it all goes wrong, then the fact that they want to take the decisions may have a silver lining.

FSA’s Director of Regulatory Strategy and Risk informs FSA’s Company Secretary that ‘[her] 3  most experienced [heads of department] in Enforcement are all seriously conflicted and I did not know this until something landed on their desk … They [sensibly] immediately told me and handed the material to me’.

On 20 August 2001 [09:23], the Company Secretary asks the Director of GCD how they should handle this, as FSA had not explored conflict of interest issues beyond Board members and front line insurance staff.

On 22 August 2001 [09:36], the Company Secretary responds to the Director:

I guess [potential conflicts] must arise with relative frequency and the individuals concerned appear to have acted quite properly in accordance with the Code … requires staff to declare a conflict to the line manager whenever it arises in the course of their work.

The Code does not itself require specific disclosure of insurance products, so I have no information on those. Within Insurance division they do have such a requirement which is superimposed on the Code. There is no such an add-on in Enforcement, so far as I know; they rely on the general provisions relating to conflict handling.

If you think this is not secure enough, then there are a number of options to consider:

1. You could superimpose a requirement for Enforcement folk to disclose insurance products they hold; but that would still leave you with the problem of how to handle the conflicts;

2. You could ask those whose conflicts have been disclosed (assuming you wanted to keep them on the [Equitable] case) to undertake not to deal in their [Equitable] policies for the time being (which is what the [Chairman] asked the Board to undertake) or you could move them to other work;

3. I could send out a general reminder to staff to be vigilant about the need to disclose conflicts whenever they arise.

[18:36] The Director says that the Chairman’s committee should state the position that should be taken.

FSA telephone HMT for an update on the work on making administration available for  insurance companies and are informed that the Economic Secretary to the Treasury wished to go ahead with a consultation process along normal lines.

The following day, FSA’s Director of Insurance comments that he hoped that this would not complicate an emergency introduction of administration for insurers, should that prove necessary.

Equitable’s Chief Executive faxes FSA a letter (dated 17 August 2001) which puts in writing a  number of concerns he had about FSA’s handling of the compromise scheme. The Chief Executive asks that a clear FSA project should be put in place, as without such a project ‘there will remain a serious risk that FSA issues may delay the timetable’. The Chief Executive expresses surprise at the points FSA had raised in relation to the pricing of options, the ‘best estimate’ compensation figures and the treatment of policyholders close to retirement. The Chief Executive asks that FSA should concentrate on the principles of the scheme proposals as, if those could be agreed ‘then the methodology and calculations should follow automatically from them and avoid needless questioning on legal or actuarial issues which is most unlikely to be productive’. He concludes by quoting his dictionary definition of ‘compromise’ (being ‘the settlement of a dispute by mutual concession’), saying ‘I do feel that that needs to be remembered by those who are attempting to put up further hurdles’.

FSA’s Director of Insurance circulates the letter, commenting:

1.This strikes me as a letter which is neither helpful nor sensible. I think however that we should respond to [the request for a clear FSA project to be put in place] [unclear] meeting – though in practice we have had regular meetings with the project team. I assume you have the right liaison point for this. In terms of project planning we are, [unclear], largely responsive to the Equitable.

2.[The concerns on the three issues raised] simply retort genuine concerns without any reasoned argument. But the guts of the letter [suggesting that FSA concentrate on principles] which, in practice, is what we are doing.

3.Let us discuss what, if anything, I should say in reply.

FSA’s Insolvency Practitioner provides comments to Legal Adviser C on Article 4 and the Financial Services Compensation Scheme, including that the approach suggested ‘strikes me as remedying a very specific ambiguity in the wording of Equitable’s articles which might not fit with the wordings in other mutuals’ articles of association’. He suggests an alternative approach which would ‘include PRE in the [Financial Services Compensation Scheme] quantification of claim rules and then to state that any restriction in the company’s liability to its members or policyholders designed to prevent a company becoming insolvent should not be taken into account when calculating the PRE value’.

[13:48] Legal Adviser E says that he and Chief Counsel A had some difficulty with that approach and suggests a meeting to discuss the issue.

Equitable send FSA some draft consultation documents for the compromise scheme.

[14:58] FSA’s Head of Life Insurance circulates the documents.

FSA’s Line Manager E circulates a revised draft letter to Equitable on FSA’s assessment criteria  for the compromise scheme. He notes that the original draft had been handed over to Equitable for comments but had never formally been sent. Line Manager E says that he has had a further thought, which was that:

… the role of the FSA is set out very narrowly in [ICA 1982] terms. However, it seems to me that with the recent proposal to extend the scheme to deal with potential mis-selling, on the basis of a breach of PIA rules, and in relation to which we might require rectification, we need to widen this considerably. I am not sure to what extent there are powers of the Secretary of State that are directly delegated to the FSA that might be relevant, but I find it hard to imagine that there are none. Also am fairly sure that there must be a corresponding role for the PIA which it derives from the rule book. I would welcome advice on that. It is important I think that we set out all the legal basis on which we would have powers to intervene or in relation to which we would wish to make representations to the court.

[14:44] The Head of Life Insurance says that this should be updated and issued.

FSA’s Actuarial Risk Review Team send the Head of Actuarial Support three papers: ‘Annuity  Options’ dated 16 August 2001; ‘Swaptions Versus Annuity Options’ dated 15 August 2001; and ‘Valuation of Annuities: Technical Note’, which appears to have been produced on 14 August 2001.

[18:32] The Head of Actuarial Support queries one of the assumptions used.

FSA meet Equitable. According to FSA’s note of the meeting, Equitable had decided not to  publish their Counsel’s second opinion ahead of their proposals for the compromise scheme. The Appointed Actuary’s company were due to present findings on the financial position of Equitable to FSA on 24 August 2001; Equitable would be present. FSA hope that the meeting would also cover the results of their work on mis-selling liabilities.

It was noted that FSA had received the six-monthly and weekly financial reporting and that the monthly figures were to follow the next day.

Equitable’s Chief Executive undertook to respond to the Head of Actuarial Support’s letter of 10/08/2001.

A number of aspects of the compromise scheme are discussed, including: the plans for dealing with the mis-selling liabilities of non-GAR policyholders who had left the fund; whether Equitable had received legal advice that non-GARs had to pay for 75% of their own compensation; GARs on top-ups; the new version of the launch document; and any problems that could delay the process.

FSA write to Equitable about their 2000 returns. FSA say that Equitable’s letter of 20/07/2001  had given rise to a number of further questions.

In response to question 1, FSA say that they were awaiting outstanding figures on the reserves held against smoothed asset shares and FSA:

a)ask how Equitable reserved for accumulating with-profits business in the resilience scenario and whether the reserves held were sufficient to meet policyholders’ reasonable expectation surrender values.

b)ask Equitable to explain why they believed the reserves held in the resilience scenario were consistent with policyholders’ reasonable expectations in that scenario. FSA also ask for comment on whether there was any implied cross-subsidy in the resilience reserves of different product groups.

c)ask what level of market value adjuster was implied by the reserves in the resilience scenario and to advise how the current adjuster of 7.5% was spread across the three components of the market value adjuster articulated in their letter of 29/11/2000.

In response to question 2, FSA ask:

a)how expense reserves were consistent with Regulation 66.

b)why different approaches were being used in the base and resilience scenarios to reserve for expenses on accumulating with-profits business.

The answers to question 3 and 4 are noted.

In response to question 5, FSA ask for more information so that they could properly consider the application for a section 68 Order.

The answers to questions 6 and 7 are noted.

FSA’s Director of GCD gives his immediate thoughts on FSA’s revised assessment criteria letter  circulated the previous day, saying that:

… the criteria should reflect the [House of Lords’] decision that everyone should get their legal rights before anyone gets a bonus. This is relevant to the concern that people can take misselling rights with them – a concern only if the compromise doesn’t give these rights their full value. Of course it could be said that the scheme must be capable of compromising these claims. But that misses the point. Legal claims for misselling can be compromised – but we need to recognize that people can only be expected to compromise them in a way that reflects their value. In the case of misselling rights the value includes the fact that as legal claims they have priority over bonus expectations.

[09:46] The Director of Insurance says that he:

… [thought] that the present version of the scheme should achieve this. The reduction in the misselling claim reflects the fact that the total pot is diminished by the value of the total misselling claim and that the portion available to fund non gar benefits is reduced proportionately, to the extent that reduction is possible consistent with guaranteed values. But perhaps we should meet to discuss: I’m nervous about too much speculative e-mail traffic, (of which this immediate response to [the Director of GCD] is an egregious example).

But I should like also to talk about the “window of opportunity issue”. [The Director of GCD] has commissioned some work from [Legal Adviser F], but it is not clear that this will necessarily resolve matters and I understand that it was not clear at yesterday’s meeting that the Society has any very clear way forward either. This is a potentially big issue on which I think we, as FSA, need a clear line before anything in the scheme is settled. And self-evidently, it isn’t a detail that can be fixed following consultation.

[09:53] The Director of GCD agrees with a suggestion that they should discuss the issue at their daily meeting later that day.

FSA’s Legal Adviser F tells the Director of GCD that Halifax have asked to see FSA’s Counsel’s  opinion.

[21:43] Chief Counsel A relays the views of Counsel in relation to this.

FSA’s Director of Insurance circulates a ‘Dear Managing Director’ letter for possible issue at the time that Counsels’ opinions on mis-selling were published.

[18:29] The Head of Actuarial Support provides comments.

Equitable provide FSA with balance sheets and profit and loss statements for 30 June and 31  July 2001.

HMT’s Director of Financial Regulation and Industry briefs the Economic Secretary to the  Treasury ahead of a meeting that is to take place with Equitable’s Chief Executive.

The Director attaches a note of a conversation with the Chief Executive that had taken place on 15/08/2001 [17:27].

FSA’s Chairman provides the FSA Board with a written explanation as to why it had been  decided not to prevent Equitable from ‘seeking’ new business after the House of Lords’ ruling. The statement reads:

As the review shows, staff met Equitable Life management before the House of Lords judgement was issued, to discuss the company’s options in the event that the judgement was highly unfavourable to the society.

The society’s management told us at that time that they would take immediate steps to provide for the new liability to guaranteed annuity policyholders, mainly by removing bonuses for the first 7 months of the year. And they would put the society up for sale immediately. They would also have to adopt a more defensive investment posture, with a lower proportion of equities in their portfolio to protect their solvency. This seemed to us to be an appropriate course of action in the circumstances.

They, and we, expected that the value of Equitable Life as a brand, together with the value of its sales force and administration systems, would be sufficient to attract a buyer. Over 15 companies quickly expressed an initial interest. The society believed that the sums available from a sale should be sufficient to allow the company to adopt a “normal” investment strategy going forward, by providing stronger backing to the fund, or perhaps even large enough to fill in the “hole” created by the House of Lords judgement and to allow the foregone bonuses to be reinstated.

In the circumstances, therefore, allowing the company to continue to write new business did not seem to be particularly risky for new policyholders. Their interests did not depend on a sale achieving the higher estimate, since the foregone bonuses applied only to policyholders with the company before the House of Lords judgement. The state of the society was well known, and particularly the fact that it was up for sale.

By contrast, to close the society to new business would have significantly reduced its value. We would have been exposed to criticism that we had damaged the prospect of a successful sale, and therefore the prospect of “putting right” the existing policyholders. Furthermore, the grounds on which the company might have been closed to new business are highly doubtful. It continued to meet its solvency requirements, and we did not think that the company’s management could be considered unfit and improper, or that they were not meeting the basic criteria of sound and prudent management.

There is, of course, a separate question as to whether the extent of disclosure of the company’s financial position to prospective new policyholders was, in the event, adequate to ensure compliant sales.

FSA’s Legal Adviser E asks Legal Adviser F to undertake ‘the critical legal task’ identified at a meeting the previous day to assess the basis on which Equitable proposed that mis-selling liabilities should be quantified. He notes that meeting Equitable’s timetable would require ‘FSA signoff’ of the compromise scheme documents by 7 September 2001.

[11:58] Legal Adviser F replies:

I don’t think that a “signoff” from the FSA side depends on [the Society’s Counsel’s opinion] being finalised or the principles he comes up with as much as identifying the principles which Equitable actually use in their calculations/estimates. One of the questions we may need to ask ourselves is whether they are following [the Counsel for Equitable’s] approach (or [FSA’s Counsel’s]), but what [the Society’s Counsel] says is not the prime question we have to address.

I think we also need to make up our mind on this aspect whether we are assessing whether Equitable’s approach is reasonable (having regard to the advice available to us and any calculations done on quantification) or whether we are suggesting a different number. I believe the approach contemplated in your report of yesterday’s meeting is the former, but if [Counsel for FSA] and we are being asked to give a view, it is only fair and reasonable for those seeking it to indicate what they want a view on.

Currently the scheme documentation is thin on how they reach their number – notably the justifications for their “calculation”. That raises the question of when sufficient information will become available – it is unrealistic to expect a view if relevant information is not available until a day or two before the deadline. It is also unreasonable to ask for a view on something which will change.

Is there yet any additional information about how/why the scheme documentation reaches the approach it does?

On 29 August 2001 [09:31], the Director of GCD says that he agrees.

FSA’s Line Manager E sends FSA’s Chairman a note on a meeting that had taken place earlier  that day with the Appointed Actuary’s company about Equitable’s financial position. The note reads:

[The company] gave us a presentation of their findings this morning. At this stage, the conclusions are in draft, and do not take account of potential liabilities for mis-selling on which work is continuing. A copy of their slides is attached.

We asked Equitable Life to appoint [the company] to report upon its financial position on three different statutory bases - the Insurance Companies Act basis, the Companies Act basis and the Insolvency Act basis. Each of these three bases, at least in theory, includes an element of prudence. The Insurance Companies Act basis is the most prudent (though it does allow an implicit item for future profits and disregards the subordinated loan liability) and the Insolvency Act basis is the closest to realistic best estimate. On all three bases, [the Appointed Actuary’s company] report a surplus of assets over liabilities. At one extreme, on the Insurance Companies Act basis, [the Appointed Actuary’s company] report that Equitable covered its required minimum margin by £758 million at the end of June 2001 (£1,025m at the end of July). At the other extreme, on the Insolvency Act basis, they report that Equitable had a surplus of £2,200m. These figures do not take into account any explicit liability for future discretionary bonuses or for compensation to non-GARs. In effect, on all three bases, [the company] have quantified the surplus assets that are available to pay the mis-selling and, after that has been paid, to fund future (non-contractual) bonuses. In advance of the finalisation of the work quantifying the mis-selling claims it is not possible to reach a definitive conclusion on Equitable Life’s ability to fund those claims. However, based on the preliminary work that has been done the level of surplus assets reported by [the Appointed Actuary’s company] as being available to meet those claims does not give us any cause for concern.

The reason for the improvement on the statutory basis between June and July is that the Society sold significant volumes of equities, switching to cash and fixed interest, which has a marked impact on the resilience reserves that are required.

The difference between the Companies Act and Insolvency Act basis is accounted for, in particular, because a degree of prudence is released from the former, by using more realistic interest rate assumptions. [The Appointed Actuary’s company] have suggested that there is likely to be scope to increase the free assets to around £3 billion on a realistic basis (although this would mean making no allowance for discretionary bonuses or the effect of large surrenders).

The work on the quantification of the potential mis-selling analysis cannot be completed until the legal position has been settled, so certain assumptions are having to be made for the time being. They are continuing the comparisons with the rest of the industry. There are already some potentially helpful signs, although the information should be treated with caution at this stage. [The Appointed Actuary’s company] have said that overall, investment returns achieved by Equitable Life (on the periods since 1988 and 1993 to the present) have been in line with the industry average, but costs are lower. This means that the position is more favourable than the average. In terms of amounts distributed, Equitable Life was around the industry average, though following the suspension in bonus allocation since the House of Lords and the recent policy value cuts, this pushes Equitable into the third quartile. The position if smoothing is taken into account apparently brings Equitable back towards the average.

The Society has provided us with a copy of an opinion by [Counsel] (which we are considering) on the reasonableness of the Society’s approach to the compromise scheme. They have also undertaken to provide us, on Tuesday, with the comparisons [the Appointed Actuary’s company] have undertaken of the relative position of Equitable’s products (broken down by type and inception year) with the market.

We are due to receive a full report on quantification next week, but the information so far would appear to support the Society’s planning assumptions in relation to the cost (subject to the legal advice on the basis of calculation).

The Appointed Actuary’s company report the financial position under ICA 1982 as at 30 June 2001 as follows:

FSA’s Actuarial Risk Review Department provide the Head of Actuarial Support with some  preliminary observations on a discussion document entitled ‘Realistic GAR Costs – Allowing for Optionality’ (dated 23 August 2001) that he had received that morning from the Appointed Actuary’s company. The introduction to the document explains that:

[The Society] has prepared some calculations on the expected realistic cost of GAR options on in-force policies. This is a vital input to the GAR/Non-GAR compromise vote. Those calculations were prepared using deterministic assumptions. In this note we explore how one might allow for possible variations in interest rates, and we produce some example calculations to illustrate the potential effect.

The Risk Review Department’s key observations are:

• that the results of the Appointed Actuary’s company confirmed FSA’s earlier point (see 21/08/2001 [15:07]) that ‘optionality (i.e. time value) can be a material component of the total value of a GAR option, particularly when the GAR option has a long time to maturity and is not very far in-the-money …’; and
• that the Appointed Actuary’s company’s approach to valuation was very similar to that used by FSA.

FSA’s Director of Insurance sends the Head of Life Insurance a note of a conversation he had  had with Equitable about Counsel’s opinion on mis-selling liabilities. The note records:

[Equitable’s Finance Director] said that he had now seen a further draft of the Opinion from [their Counsel]. It had been drafted by [his] junior and was significantly different from what they had understood [Counsel for Equitable’s] current view to be from a conversation they had had with him yesterday. It was not clear whether it would be where he would finally end up, but they were not confident that it would change. [Counsel, who were advising the Society on the Compromise Scheme,] (and they understood [Counsel for FSA]) thought it was seriously flawed. But if he stuck by it, and it therefore entered the public domain, it would be a material factor in their efforts to secure agreement to a reasonable and fair scheme.

In short [the Society’s Counsel’s opinion] was “becoming more aggressive on misselling”. He was tending to the view that all cases should be treated as advice cases; and that the full cost had to be borne by the GAR policyholders rather than the non-GARs, the effect of which was to require that misselling costs should be grossed up to take account of damage to future bonus prospects.

Given the strength of [Counsel advising the Society on the Compromise Scheme’s] contrary opinion he said that the directors were likely to treat this position as “one of a number of disparate legal views”. They would not be inclined to try to give full effect to it in the scheme. It appeared that [Counsel for Equitable’s] intention was simply to reverse the effect of the House of Lords’ judgement and achieve ring fencing by a different route. They were not convinced that [he] had fully understood the implications or, indeed, the way that the fund operated. They would try to get him to understand but were not optimistic. [FSA’s Chief Counsel A] confirmed that [Counsel for FSA] would be prepared to talk to [the Society’s Counsel] if the latter approached him.

[Equitable’s Finance Director] asked whether we envisaged publishing the [Counsel for FSA’s] Opinion – he had understood that we did not. We said that we did intend to do so, together with some more general indication to the industry that they should consider the implications. [He] said that this would be helpful, especially if they needed to distance themselves from [the Society’s Counsel]. He said that they were rethinking their strategy on publication of the scheme. They were now absolutely clear that they would not publish [their Counsel’s opinion] ahead of the scheme. They were toying with the idea that they might publish the scheme with an opinion from [Counsel for Equitable] endorsing it as fair, taking account of a range of legal opinions including [Counsel’s own opinion] (and if possible [the opinion of Counsel for FSA]). [The Society’s Counsel] might then be published a day or so later. However this was far from certain.

We asked about the implications for solvency. [The Finance Director] said that since they had no Opinion from [their Counsel] at this stage it was difficult to know what weight to give it. [Counsel advising the Society on the Compromise Scheme’s] advice was clear and the directors would not be justified in taking any precipitate action at this point: they had in any case a reasonable prospect of resolving matters effectively through the scheme. He accepted however that the Insurance Companies Act position might prove more problematic, and could present us with some difficult decisions.

FSA’s Chief Counsel A writes to the Director of GCD further to Line Manager E’s note of  24/08/2001 [16:11] and the Appointed Actuary’s company’s presentation on Equitable’s solvency position. She says that this ‘interim’ report was broadly ‘good news’ but that she needed to draw his attention to three issues: Article 4; the market value adjuster; and the Society’s retirement age assumptions. On the first issue, Chief Counsel A writes:

… [the Appointed Actuary’s company] say they understand the Equitable Board has been advised that they cannot become insolvent because of [Article] 4 (and therefore wrongful trading cannot arise). If this is so (I have not checked), this is a change of position and it is not obvious to me how we can in the face of it justify continuing to assert that the [Policyholders Protection Act 1975] will apply without (at a minimum) making clear there is a contrary view. I think this is probably so even if the [Policyholders Protection Board’s] position is the same as ours (so far as I am aware their Counsel has still not opined). In addition, we do not know and have not considered what the implications are for the presentation of the GAR/non-GAR scheme. I think the first thing to do is ask [Line Manager E] to ascertain the position from the Equitable. Then we can take it from there.

On the market value adjuster, Chief Counsel A says:

… [the Appointed Actuary’s company] say GAD (presumably our Actuarial Support team) accept that the MVA can be [used] to prevent prejudice to remaining policyholders in the event of mass surrender. This suggests the ability to use the MVA actually to discourage (or penalise) surrenders where this is appropriate to protect remaining policyholders, rather than merely to ensure that policyholders do not take away more than asset share. Our actuaries may have that view (I have not checked) and that is my preliminary view, but I am not aware that legal advice has been requested or given on this issue. Perhaps [Legal Adviser C] can comment.

On the final issue, Chief Counsel A notes that ‘[the Appointed Actuary’s company] says that assuming GARs retire at the earliest date is generally prudent, but they have not checked that it is prudent in all cases. [Legal Adviser A] has I think instructed Counsel on the regulatory requirements in this area and I ask him to remind us what that advice is. As [the company] says, this is a second order issue’.

FSA’s Head of Life Insurance asks that any comments on the compromise scheme consultation documents, circulated on 21/08/2001 [14:03], should be passed to Line Manager E by the end of that day.

[14:38] The Insolvency Practitioner provides detailed comments on the letter to policyholders, which include:

• The emphasis remains on the society investing more freely for growth and adopting a more generous bonus policy if the compromise is agreed. Are we satisfied that this is not a misleading statement? The society has not said how their investment policy would change, and it is unlikely that it would change. Equally, there is no indication as to what bonus policy the society would follow after the scheme;
• In the “what next” section there is no mention of the pre-hearing to determine classes. Neither is there mention in the “how do I know it is fair” section that each group of policyholders will be represented at that hearing; and:
• … they say that the scheme document will be sent with exact details of how it will affect each policy, but we want the society to send each policyholder an actuarial estimate of the value of the GAR rights being given up, not just the uplift offered in return. It would be helpful to extract this commitment from the society now.
• On the consultation document, his comments include:
• … I think that the statement “Policies will be much safer and are likely to grow faster after a compromise” is misleading and at the least requires the society to state how its investment policy will change if the scheme is approved. Same comment re the penultimate sentence on page 5: “The restrictive investment policy and cautions bonus policy is likely to lead to significantly lower growth on all policies.”;
• … I wonder whether it is true that [the Society’s auditors] “have verified” that the calculations are “correct”? I would be surprised if they expressed anything in this form and wonder whether their work will be directed at the figures in the explanatory statement rather than any of the calculations in the launch papers;
• … The GAR cost is estimated at £1.2bn but the non-GAR misselling claims are estimated at £1.0bn – why the difference? The first sentence on page 11 suggests that [the Society’s Counsel] has put a £1.0bn value on claims and I doubt he has mentioned any figures; and:
• … I agree that “after a compromise” … “bonuses will have to be prudent to ensure strength is maintained” and this should be the consistent tone throughout.

[15:23] An official from FSA’s Press Office comments that Equitable: ‘need to explain clearly to people where the money is coming from. There has already been press coverage suggesting that people had 16% knocked off their policy values and are now having some of it given back, so where is the money to come from? Equitable need to come up with an understandable answer to this fundamental question or face constant policyholder and press suspicion over the whole deal’.

[15:37] Chief Counsel A agrees with the Insolvency Practitioner that Equitable should say something about the convening hearing.

FSA’s Chief Counsel A responds to the Director of GCD’s request of 03/08/2001 [10:59] that  she should examine whether the Baird Report might impact on the compromise scheme. From a very quick review of the report, the Chief Counsel notes two issues:

1. There are some very occasional factual errors which might cause the press and policyholders to misunderstand the position or raise doubts about what they are being told by the Equitable. For example … it is said that in 1998 GARs were approx. 30% higher than CARs. This may be true on average (I do not know), but the range of GARs is considerable and the 30% figure may therefore tend to mislead (and raise expectations).

2. [The report] recommends … that GARs be valued stochastically and consistently with traded option prices in the market. We are doing that for our own purposes internally (to establish the value of GAR rights given up, against which the fairness of the uplift should be judged), but I am not aware that Equitable are doing it. So the publication of the Review Report might tend to support arguments that the uplift has not been shown to be fair.

But both these matters do not seem to me to be significant. I do think though that someone ought to go through the Report line by line in due course with the GAR/non-GAR scheme in mind. I am sorry but I am not able to perform that task due to pressure of other work.

As an aside presumably the very publication of the Review Report will give Equitable policyholders an opportunity to get angry all over again, so there is reason to delay publication if possible by a couple of weeks after publication of the GAR/non-GAR launch document and the misselling opinions.

FSA’s Legal Adviser F provides Chief Counsel A and the Director of GCD with his concerns about the mis-selling aspects of the compromise scheme documentation. The Legal Adviser explains:

The description of the scheme suggests that it deals with the whole of the company’s assets, and that the whole of its assets are currently attributable to its current policyholders. It then goes on to describe the way in which the cake has to be cut differently to how it is at present, taking account of the various kinds of liabilities which exist. Thus it goes on to describe that the misselling liabilities have to be borne as to 73% by the non-GARs.

If this is truly what is going on – ie showing how the entire cake is to be divided up among the existing policyholders – then I am concerned that the company is not allowing properly for its other actual and contingent liabilities. I suspected that this was not the case, but the various balance sheets put together by [the Appointed Actuary’s company] reinforces that.

Thus I think what is going on is that the company is telling the relevant policyholders that ultimately the net assets belong to them as opposed to everyone else. Thus it is appropriate to tell them how their asset share (much of which will be a contingent share not a current one) will change as a result of the scheme. This leaves out the middle step of saying that the actual payment for misselling claims is from the current free assets (ie which have not been allocated to bonuses) and (presumably) the same for the GAR buyout sums there is presumably also some provisioning for other creditors, actual and contingent against the same free assets. Leaving out this middle step exposes the company (and FSA) to later allegations that policyholders are having their policy values reduced as a result of payments made to former members to compensate for misselling etc. I would not discount the possibility that someone might seek to attack the scheme on those grounds.

I do think that this middle step is vital to the misselling (and probably other) aspects of the scheme, and that leaving it out potentially prevents a proper understanding by a lay member of what is truly going on (assuming I understand it correctly), and thus could preclude its meeting a “fair, clear and not misleading” test.

[15:39] Chief Counsel A asks Legal Adviser F if she could have ‘a quick word about this’.

FSA hold a ‘wrap-up’ meeting. The Director of Insurance circulates the key points of the meeting later that day which include, under ‘Financial Position’:

No points of clarification or doubt on the [Appointed Actuary’s company’s] presentation. Not clear when we would receive final report - presumably not before misselling work by [the Appointed Actuary’s company] was complete. We needed to consider whether, and if so what and when, we should make public about the fact that we had required this work and what the results were. NB the work was expressly confidential to the Society. We had no gateway to allow publication. ([Chief Counsel A]: to confirm?). But presumably we could disclose that we had required an independent review of the financial position which did not give rise to any doubts about the Society’s statements. NB too that the half yearly results will be published with a statement from the auditors (the auditors will want to talk to us first to ensure both that we understand the uncertainties and to make sure that we do not know anything they do not!). Action: [Head of Life Insurance]. We should discuss further with [the Society’s Chief Executive] tomorrow to find out when they will publish their half year figures and what, if anything, they will say at the time of the launch.

FSA’s Director of Insurance writes to Chief Counsel A, after a discussion the previous night, about what FSA should do in the light of Counsels’ opinions on mis-selling by Equitable and whether they should require Equitable and/or the industry to undertake a review and, if necessary, implement a rectification scheme. The Director of Insurance seeks the advice on the legal implications of what he had in mind, which was:

a) The FSA has made no final determination as to whether misselling took place or loss was suffered in respect of the non disclosure of GAR exposure. However in the light of legal advice provided to the Society and to the FSA it seems clear that policyholders are likely to be able to bring successful claims for compensation.

b) The FSA is aware that the Society is seeking to resolve these claims by offering [compensation] as an essential part of the proposed compromise scheme under s425. The FSA considers that this is an appropriate way to proceed, and does not intend to take further action until the results of the vote on the scheme is known and the issue has been considered at the court.

c) However, in considering whether or not to vote for the [scheme], policyholders are entitled to know what the FSA would be likely to do if the scheme is not endorsed by policyholders and by the court. In these [circumstances] the FSA, consistent with the advice provided to it by leading counsel, would be minded to require Equitable to review policies sold by it to non GAR policyholders and, where appropriate, to offer redress. Where it was reasonably clear that policyholders, had they known of the GAR exposure, would not have bought a policy from the Equitable then the redress payable would be the difference between the value of the policy they actually bought and the value of an average performing [comparable] product bought from another provider. Such redress would however be subject to two important limitations:

(1) The total cost of redress falling on the Society should be limited, as a maximum, to the cost which it may reasonably be estimated to have to in meeting its GAR liabilities;

(2) Since the cost of meeting misselling costs falls on the with profits fund, of which non GAR policyholders are 75% owners, the redress payable to such policyholders should be reduced by that proportion.

[16:51] Following a meeting with the Director of Insurance and Chief Counsel A, Legal Adviser F writes to the Director of GCD to provide guidance. He explains that they:

Broadly … agreed that FSA ought to prepare itself to take appropriate lines about reviews and rectifications, and that the sort of matters which [the Director of Insurance’s] email identifies are broadly the right ones. However we all agreed that the drafting would need some attention in tone and wording – given that it is important for [Conduct of Business] Standards to be content (with appropriate input from Enforcement and Consumer Relations) and its obvious links to the misselling lines more generally we wondered if the drafting might be led from [Conduct of Business] Standards assisted by [the General Counsel’s Division]. This is something which may be discussed at the wrap up meeting.

We did however identify that there may be a number of other aspects which might need to be covered – such as the difficulties in proving a case and assessing damages (the fraught legal issues), the ongoing right to seek redress by individual policyholders pending any FSA imposed review etc, the potential involvement of PIA’s areas (given that the s425 consultation documents may trigger the need to have lines, and we expect their publication ahead of [FSMA 2000 coming into force]).

FSA’s Chairman is informed by the Economic Secretary to the Treasury that HMT have decided to commission an inquiry into Equitable (the Penrose Inquiry) and that HMT intended to make the announcement of this on 31 August 2001. FSA’s file note records:

[HMT’s] primary handling concern was to minimise the possibility that the compromise scheme would be disrupted and, to this end, they were extremely concerned not to give the impression that government support would be forthcoming as a result of the review. Therefore, they planned to emphasise the extremely high hurdles that would need to be met before the possibility of any government [support] in the statement and background briefing that would accompany the announcement. The [Economic Secretary to the Treasury] asked if we would be able to support this in public. [FSA’s Chairman] noted that it would be difficult for us to do so as it is not for us to say whether there might be a government liability. He noted that it would look odd for us to comment on the principle when, under [FSMA 2000], any awards assessed against the FSA by the Complaints Commissioner would be payable from industry fees.

[The Chairman] asked at what point in time the remit of the inquiry would stop. The [Economic Secretary to the Treasury] said that it might well need to go beyond the close of the Equitable to new business and it was hard to see a definitive stop point after that. [The Chairman] expressed concern that this could lead to the inquiry reviewing work as it was happening, which would hinder the compromise scheme. It was agreed that HMT would look for a form of words to say that the initial work of the inquiry would be to look at the origins of the problem and that the inquiry will not be influencing the compromise scheme, although it may cover issues relating to it in its final report.

The [Economic Secretary to the Treasury] saw it as an advantage that HMT were announcing this ahead of having received [the Baird Report]. The briefing would emphasise that HMT had full confidence in the Baird review but the public interest was so strong that the narrow remit of [the Baird Report] could no longer be sufficient. [FSA’s Chairman] asked whether this would effect the publication of the Baird review. The [Economic Secretary to the Treasury] said this would need to be discussed with Penrose when HMT received it. [The Chairman] emphasised that any delay would put the FSA in a very difficult position, both in terms of our position in front of the [Treasury Select Committee] on 16 October and not being able to take forward the recommendations for the future, which would require public consultation. The [Economic Secretary to the Treasury] said that HMT were still committed to its publication but would need to consider the timing.

FSA also speak to HMT to clarify a number of points and it is agreed that a meeting would take place on 29 August 2001, after HMT had sent FSA the draft terms of reference and associated material.

FSA’s Legal Adviser C tells Chief Counsel A, in response to her note of 27/08/2001 [15:44], that neither he nor another legal adviser had been asked to advise on ‘using the MVA as a sword rather than a shield’. However, the legal advisers were in the process of seeking advice from Counsel on the market value adjuster and this point could be included, if that was thought appropriate.

[21:26] Chief Counsel A agrees that it would be right to ask for Counsel’s views, but says that ‘any instructions would require careful actuarial input, and I do not think that can be provided to your timescale’.

Equitable send FSA final draft documents for the compromise scheme.

[17:05] Line Manager E circulates the documents within FSA, saying that he would attend an all-day review meeting about these on 31 August 2001.

FSA’s Director of Insurance circulates a ‘Skeleton Submission on Equitable’ about the compromise scheme for discussion at a meeting that evening. The submission sets out the ‘Issues for Decision’ by FSA as follows:

a) Should FSA intervene in relation to consultation on the proposed S425 scheme

• To require the Society not to proceed;
• To require any modification to the proposals themselves;
• To require any modification to the presentation of the proposals, the background, or the reasons for/alternative to them.

b) What should the FSA say

• About the proposals;
• l About FSA’s role in relation to them - (including the criteria by which we will evaluate them?);
• l About mis-selling, and possible regulatory action in relation to mis-selling;
• About the financial position of the Society and/or the independent review of this.

c)What should FSA say about wider implications for the insurance industry?

The recommendations put forward in the submission were:

S425 scheme

a) Subject to resolving continuing uncertainties over mis-selling liabilities, the Society’s proposals are not such that we should seek to prevent their presentation to policyholders as a basis for consultation.

b) There are no major unresolved issues (mis-selling quantification apart) which should lead us to require more modification to the proposals.

c) Presentation remains an issue. We should work with the Society to improve the drafting. The only issues where we may need to require change are:

• Reference to the position of the FSA and its legal advisers
• Exaggerated reference to the uncertainty of litigation in relation to mis-selling claims.

FSA Position

• In relation to the proposals, we should note these as an important step towards a compromise scheme, which FSA believes is likely to be the most appropriate way to resolve the Society’s difficulties. We await the results of the consultation exercise.
• On the role of the FSA, we should give a factual account of our responsibilities; say that we will continue to monitor the financial position of the Society very closely; will work closely with the Society as they develop their proposals in the light of policyholders comments; will wish to satisfy ourselves that their final proposals meet our criteria, will ensure that they are fairly and clearly presented, and will set out an analysis of the evidence to the Court.
• On mis-selling we should say that we have not reached any formal view on mis-selling, but note the legal advice given by [Counsel for Equitable] and [Counsel for FSA]; that we note the intention to include mis-selling claims in the compromise scheme and accept that there is an appropriate way to proceed; explain what we would do by way of review/redress in the event that the scheme is not endorsed by policyholders or the court.

The Skeleton Submission also discusses timing issues, regarding which it is stated that FSA should aim to communicate their decision to Equitable by 6 September 2001, while noting that they could intervene to prevent the launch later than this if necessary.

Legal Adviser F provides the Director of GCD (copied to others) with advice on the potential liability of former members of an unlimited company. The summary of his advice is that:

Two potential sources of liability occur to me (looking only at their position as former members of a body corporate rather than in any other capacity):

a)the potential for being required to contribute to the company’s assets so that it can meet its liabilities; and

b)the possibility that they may have received distributions from the company which were unlawful (akin to dividends paid when there are no accumulated profits to distribute).

Having looked into these I do not think that either are of practical benefit in the current situation: the former because of the timing, and the latter because of the speculative nature of the claims.

FSA’s Director of GCD responds to Legal Adviser F’s request for guidance of the previous day (see 29/08/2001 [16:50]). The Director of GCD writes that he:

… [thinks the Director of Insurance] is looking for advice on the substance of the proposal that we would limit the amount we would mandate to what-effectively-people would get under the 425 scheme. Can you focus on this? Would probably need to be done by own initiative variation, as an executive procedure decision, subject to review by the tribunal, would arguably mean giving less than court or ombudsman would award, and less than on any other misselling. Would be criticized as subordinating interests of misselling victims to desire to see 425 scheme agreed. Legally sustainable? May depend on reasons, which [the Director’s] note doesn’t articulate but related to desire to avoid regulator mandated redress offering an apparently better deal for leavers to that available under the 425 for stayers. Also – need to get view from [Counsel for FSA] when issues identified.

[09:45] Legal Adviser F says that he agreed: ‘but our comments immediately re-raise a major concern I have about the 425 scheme (hopefully a presentational one). If the scheme is massively out of kilter (lower) with what the court/ombudsman would award (on our best guess/advice etc) then how can FSA possibly stand by and be seen to endorse it as fair? If it is fair under the 425 scheme, then why would FSA be under attack for the matters you mention?’.

[09:52] The Director of Insurance replies to the Director of GCD (having not seen Legal Adviser F’s comments) saying:

As to policy reasons underlying the approach to discounting it is partly as [the Director of GCD] suggests. But as we discussed I think it is as, if not more, important that we recognise that “grossing up” (to put it the other way) could produce a level of claims by individuals which, if granted to all, would damage the fund, perhaps ultimately to the point of insolvency. We could not allow payments to be made to early birds at levels which would damage others later in the queue. We would, depending on what amount we required by way of reserves have either to petition for winding up (if the Society did not do so), apply to the court for a reduction in policy values (if preferable to a winding up) or, at the very least, require to the company to reduce/suspend non contractual payments. The net effect on the “missold” policyholders would be likely to be at least as bad, if not worse, than the approach I have suggested which, in effect, mirrors the approach which [Counsel for FSA] advises is appropriate in the context of the scheme – and for much the same reasons.

Even though it seems to me defensible on grounds of common sense and fairness, I recognise that it may be legally difficult although I was encouraged that at our discussion yesterday there appeared no obvious problem. But as we agreed it will be very important that we have explored all the angles and that [the FSA’s Counsel] provides supportive advice.

Further to the discussion on Equitable’s draft compromise scheme documentation on 28/08/2001 [10:42], FSA’s Insolvency Practitioner says that he agreed with the official and says that he thought that: ‘some basic explanation of how a with profit fund works and in particular how policy value (and guaranteed value) relate to asset share is vital. The essence of the “deal” is how to carve up the remaining free assets of the Society: there is no new money. If the Society does not explain it in these terms then we should. However, I don’t think we can provide such supplementary information until the final scheme is published (ie October)’.

[11:47] The official agrees with the Insolvency Practitioner and notes the Director of Consumer Relations’ view that FSA should not be forced into doing Equitable’s job for them and that Equitable should properly explain this point, and others, to their policyholders.

FSA’s Insolvency Practitioner comments on the issue of Equitable repurchasing the subordinated loan, following the meeting with Equitable held the previous day. He says that: ‘Such a repurchase would not amount to a preference since the society is solvent at the time of the transaction’.

[13:02] In reply, the Director of Insurance adds:

Solvent, but subject to fundamental uncertainty as to the quantum of misselling claims from policyholders. And the debt is subordinated. I don’t think we should risk giving our consent in these circumstances. We should indicate that we need to see the uncertainty reduced before we could allow money to be paid out to those whose interests are subordinated to those of policyholders.

PIA provide FSA with a draft statement of what FSA might say on 19 September 2008 at the time of the launch of the compromise scheme consultation, about a review of redress for mis-selling by Equitable required by the regulators. PIA’s note takes account of the discussions which had taken place about this on 29/08/2001 [09:46] and earlier that day (see [09:26]). PIA explain:

The underlying concerns expressed in [the exchanges that morning] were reflected in my comments yesterday evening on your draft submission. That is, what is our desired outcome/result of the compromise agreement. If, for example, we believe that it is in everyone’s interest for the package to be accepted (including on the grounds of the greater good) then, in the circumstances of the time, it can only be regarded as fair and reasonable.

If, on the other hand we take the view that such fairness and reasonableness is dependent upon maximising the opportunities for non-GAR policyholders to get the maximum compensation, then manifestly we can only advise that they should leave their options open. To head this one off we would have to get the [Financial Ombudsman Service] to sign up to our position (which I would have thought they could do without compromising their freedom to look at each case individually). That would leave the courts as the only alternative avenue still open.

The attached could be laced with more explicit warnings that the society can/could stand only so much financial strain before insolvency beckoned, including as a result of any “better deal” from the [Financial Ombudsman Service]. The problem here is that attention could turn to an industry (or even Government) bail out.

We can only decide what to say and how far to go once we have [crystallised] the outcome we want from the compromise agreement and whether or not we have a chance of getting the [Financial Ombudsman Service] to buy-in to our position as set out in the attached.

[16:41] The Director of Insurance thanks PIA and returns the statement with some suggested amendments. In reply to what FSA’s policy objectives were, the Director says that he saw them as twofold:

a) I think that policyholders do need to know the probable consequences of not approving the scheme, whether good or bad. This is the approach we have insisted the Society take in presenting the scheme – hence the detail on winding up etc in the documentation. It is also consistent with the criteria we are applying to our attitude to the scheme that in its component parts and across the piece that it should represent a fair exchange between what policyholders are gaining and what they are giving up, and that this should be clearly explained. In giving up misselling rights policyholders are giving up whatever review/redress scheme might give them, and they need to understand what this might involve and what it might mean for them.

b) I believe that to ensure that policyholders understand the alternatives, and in particular what might be involved in a review/redress scheme, it is not enough that we should make the Society cover this in their literature. The Society cannot know how we would approach this. It is reasonable that policyholders should look to us for this. If we are to provide information on this, we need to be clear how we would handle such a scheme in the particular circumstances of the Equitable and what the practical constraints might be. An essential part of this is to determine, in principle, whether a redress programme would follow a “grossing up” approach (in which case we would probably need to intervene to avert some of the undesirable consequences) or whether it would not.

An incidental benefit of this is that what, on the legal advice we have received, we would regard as unrealistic expectations by non GAR policyholders as to the potential value of misselling claims does not distort the vote. But I don’t think our objective is to give the scheme the best chance of success. It would be inconsistent with our overall approach to do other than to ensure that policyholders have the clearest and most reliable information that can be provided (in a very uncertain world) on the issues which are relevant to the decisions they have to make.

Legal Adviser F sends the Director of GCD, Chief Counsel A and Legal Adviser E a copy of the possible statement by FSA on the review and redress (see 30/08/2001 [16:41]). The Legal Adviser says that he was ‘not happy with it in this form, but am content that it is heading in vaguely the right direction’, although he had one major reservation as to whether some of the content was appropriate for the general public.

[21:31] Chief Counsel A agrees with Legal Adviser F that the drafting needed work and that the underlying policy had not yet been sufficiently well thought through.

Equitable’s solicitors send FSA an actuarial summary document to be included in the compromise scheme documentation.