September 2001

FSA’s Line Manager E circulates the actuarial summary document received on 31/08/2001 [21:00]. The Line Manager explains that this was intended to be included as an annex to the background document and contained the technical information on how the compromise scheme had been put together and the assumptions used. The Line Manager notes that, because of this, it was aimed at commentators and advisers rather than ordinary policyholders.

[10:57] The Head of Actuarial Support says that he still had reservations about:

(1) The description of the comparison of fund performance and payouts for non-GAR policies in paragraphs 2 and 3 where I have not been able to reconcile their figures with those from other sources … and where I also believe that they should be looking at single premium [policies] and not just those with monthly premiums.

(2) There is no explanation of where the comparison figure of £250 million in paragraph 5 has come from.

(3) The proposed uplift for pre-75 policies looks rather too high, though the cost of this and hence the effect on other policyholders should not be significant.

Equitable write to FSA setting out their continuing concerns in relation to the planning process for the compromise scheme and fundamental concerns in relation to Counsel’s opinion on mis-selling liabilities. Equitable’s Chief Executive says that he was:

… deeply concerned by your suggested approach to the forthcoming legal opinions. We do not intend to admit liability for several very fundamental reasons:–

1. There is no legal certainty arising from the views of [Counsel for FSA and Counsels advising the Society on mis-selling claims and on the compromise scheme]

2. [Counsel] is our QC for the scheme and, if he is content that what we are proposing is fair, we will go ahead with it.

3. There is continuing uncertainty over quantum.

4. The position of ex-policyholders should not be high on the priority list. [Equitable’s Finance Director] thought he had your agreement that this point could be considered later, if appropriate.

Our purpose is to deal with the uncertainties by the compromise proposal and we would have to be strongly opposed to any FSA action which put this at risk.

The potential mis-selling claims are a consequence of the House of Lords decision. I remain disturbed that the FSA, when asked the direct question, refused to say that it found the House of Lords judgement perverse.

FSA’s Director of Insurance forwards the letter to the Head of Life Insurance, commenting:

I think this letter reflects grave lack of understanding … as I have reiterated to [the Chief Executive], our position is that we have not yet determined that there has been misselling. But we are concerned about what we and the Society should do if it is found. We would expect to give some indication of this on the 18th. The Society should be prepared for the consequences retrospectively as well as prospectively. I will try to distribute a response this pm.

FSA’s Head of Life Insurance circulates a revised version of FSA’s information sheet ‘Questions and answers about Equitable Life’, last revised on 16 August 2001.

The answer to the question ‘Is Equitable Life solvent?’ has been amended and the answer ‘Yes’ removed. The paragraph continues: ‘Equitable Life made clear in its annual accounts and in its regulatory return (a report that it must make to us), that it continues to face some fundamental uncertainties – for example, in relation to the cost of its liabilities to the Guaranteed Annuity Rate (GAR) policyholders’. The word ‘regulatory’ is also inserted into the following sentence: ‘However, the latest figures we have received from Equitable Life show that it continues to meet its regulatory solvency margin requirements’.

The word ‘projected’ is added before ‘policy values’, where it is mentioned.

FSA write to Equitable to confirm the points that had been discussed over the past several weeks about how FSA saw their role in relation to the compromise scheme.

FSA set out their powers of intervention under sections 38 to 45 of ICA 1982 and state:

The FSA will need to consider from time to time throughout the process leading up to the final hearing of the section 425 scheme whether it would be appropriate to exercise any intervention powers. It will wish to consider whether it should convey its views on the scheme to policyholders. It will also wish to consider whether it would be appropriate to appear in Court either to make representations relative to its own role to protect the interests of policyholders, or to assist the Court where it can in assessing the effect of the scheme (and the alternatives to a scheme) on policyholders and by explaining the FSA’s own approach in assessing the scheme.

FSA explain their criteria for assessing the compromise scheme:

In considering the scheme, we envisage a two part analysis. The first part would look at, for each relevant group of policyholders, the proposal put to them and whether it represents a “fair exchange” for the rights they are being asked to give up. In this part of the analysis, we would also look to make a comparison between the benefits and disbenefits of the scheme to each group of policyholders taking into account the benefits and disbenefits that could arise if the scheme did not go ahead, and the uncertainties surrounding the alternatives to a scheme.

In the second part of the analysis, which would only become relevant if the first test were passed, we would look to make an assessment of whether the scheme gives disproportionately greater benefits to some policyholders compared with others and whether the disbenefits fall disproportionately on some.

In order to make the assessments referred to above, we will need to consider the proposals for valuing and buying out GAR rights and rights that might arise in relation to mis-selling claims and in doing so, take into account any likely outcomes in the event the scheme did not proceed.

In relation to the buyout of the GAR rights, we will be considering:

• For those with GAR policies: whether the proposed uplift, taken with other prospective benefits, is a fair exchange for surrendering the GAR.
• For those with non-GAR policies: whether the cost of funding the GAR uplift is a fair exchange for the benefit associated with avoiding the continuing (but variable) exposure to GARs.
• We will also need to undertake an equivalent analysis in relation to the mis-selling claims (having regard to the responsibilities and powers of the FSA and PIA under the Financial Services Act 1986, and, in due course, the similar provisions under the Financial Services and Markets Act 2000) to take a view as to
• For those with non-GAR policies: whether the redress offered under the scheme is a fair exchange for giving up possible mis-selling claims, taking into account the amount of redress that might be obtained by other methods, including through the Courts, the ombudsman or compensation required by the regulator to be paid by Equitable Life, and the likelihood of success of such claims.
• For those with GAR policies: whether the cost of funding the buyout is a fair exchange for avoiding the continued (and uncertain) exposure to potential mis-selling claims.

We do not believe that it would be practicable or appropriate to consider those points in relation to each individual policy or policyholder. However, we will wish to assess, in relation to each question, whether there is any group of policies or policyholders within the relevant categories for which the answer would be significantly different than for the generality of that category, and if so whether such a group would be unfairly advantaged or disadvantaged.

Lastly, FSA set out their views on the information to be provided to policyholders:

We attach considerable importance to the timely provision of relevant information to policyholders in a form that will enable them properly to understand and assess the proposals they are being asked to support. We see the information being on two levels: an assessment of the overall consequences of the proposed scheme and alternatives to it (including continuing the run-off or liquidation), and the information policyholders will receive illustrating the range of consequences for them under the scheme compared to the alternatives.

Equitable’s solicitors send FSA the latest versions of the compromise scheme launch documentation.

[10:45] Line Manager E circulates the latest versions of the launch documents received that morning. He later [18:14] says that the information had been revised where Equitable had realised that they had made a mistake in relation to the treatment of pre-1975 GAR policies.

FSA’s Head of Life Insurance provides some comments on a draft letter to Equitable about the compromise scheme. The Head of Life Insurance tells Chief Counsel A that her detailed drafting comments on mis-selling and the legal position had not been included.

[11:32] Chief Counsel A notes that the wording she had provided had been cleared by Counsel.

[12:35] Having reviewed the letter on behalf of Chief Counsel A, Legal Adviser F says that he would be: ‘uncomfortable in not putting the sort of wording which [Chief Counsel A] put forward in this letter, given that we have had counsel’s advice as strong as this (particularly since it reinforces the internal concerns). As it stands the letter could be read as indicating a lowish level of discomfort on the issue, whereas the truth is rather stronger. Surely ELAS would be extremely annoyed with us if the letter glossed over something we see as one of our main outstanding concerns?’.

FSA reply to Equitable’s letter of 03/09/2001. FSA confirm that they had received the information from Equitable’s Appointed Actuary to enable them to review the assumptions and calculations underlying the Society’s quantification of potential mis-selling claims. This assessment had been based on a comparison with an industry average of comparable products. FSA say that they had set out some areas of concern and were to meet with the Appointed Actuary on 5 September 2001 to go through those concerns.

FSA say that their legal team had ‘some serious reservations about the way the legal analysis on which the quantification of potential mis-selling claims is explained in the launch documents [for the compromise scheme]’. Those concerns related to the explanation of whether all non-GAR policyholders had suffered loss which ‘has so far not been demonstrated’. FSA understand that Counsel had now discussed this, as had been agreed previously.

FSA set out their views, following Equitable’s letter of 03/09/2001:

I should confirm that I had not suggested that you should admit liability to mis-selling or that any claims in respect of mis-selling should be treated, for the purposes of the proposed compromise scheme, as other than “potential”. However I was, and remain, concerned that, at least in the latest version of the documentation that I have seen, much is made of the uncertainties of litigation as justifying the discount which you propose should be applied to the quantification of potential claims. As you know, my view is that since litigation is not the only basis on which policyholders might expect to see such claims pursued, such discount factor as is applied should reflect the full range of possibilities. This should include claims resolution via the ombudsman and the possibility that, if mis-selling were to be found, the FSA might require the Society to review and offer redress for affected policies. I should emphasise that this latter is not a foregone conclusion: we have, in fact, reached no view on this one way or the other. But equally, it does not seem to me to be something which can simply be ignored. Indeed, this possibility makes it all the more important that the FSA should be able to come to the view that the scheme which you are putting forward is fair in respect of potential mis-selling claims. If we are able so to satisfy ourselves, then we may be able to indicate, at least in response to any questions put to us, that policyholders should not expect that any review/redress process, which we might mandate, would produce a better outcome for them than they would achieve under the scheme.

On reserving for potential mis-selling liabilities, FSA say:

You will recognise too that, as we have pointed out in earlier discussions, the Society will need to be able to meet any costs that might arise from mis-selling claims by non-GAR policyholders who have surrendered their policies, or whose policies have matured, before the scheme is promoted and whose potential claims will accordingly not be compromised under it. For that reason some quantification of this potential liability is also necessary. Such quantification should also factor in the possibility of FSA mandated review/redress.

On the House of Lords’ ruling, FSA say:

I do not believe it would be possible for the FSA to characterise a ruling by the House of Lords as “perverse”. On the issue of guidance, the FSA gave very careful thought to whether it could offer guidance on the implications of the House of Lords judgement for life offices generally, but it concluded that the implications were so closely related to the facts of the particular case that generic guidance to the industry was at best unlikely to be helpful, and at worst could be misleading.

FSA take the opportunity to reply to Equitable’s letters of 17/08/2001 and 24/08/2001 about the compromise scheme, noting that a number of discussions on this issue had taken place since then and that they had set out FSA’s criteria for assessing the fairness of the scheme in their letter of 03/09/2001. FSA say: ‘At a more detailed level, we are now more comfortable on most points where we had raised questions or concerns, subject to the points I have made above, and the fact that the scheme itself is not yet finally settled’.

FSA write to Equitable before the meeting that afternoon to say that the agenda had been largely set by their letter of 03/09/2001. FSA list the specific topics that FSA would like to discuss as: legal analysis of mis-selling claims; treatment of mis-selling claims for people who had left, or might leave, the fund before the compromise scheme was in place; and uniform uplift for non-GAR policies.

[11:33] Equitable telephone FSA before the meeting to relay a request from their Chief Executive that FSA should confirm that the mis-selling issues were the only outstanding issues they had. Line Manager E informs the Head of Life Insurance that he: ‘explained that we are not in a position to do that since there are others in the organisation who will need to express a view (eg the Chairman) and that we have not been able to consult him properly when we [are] still dealing with some of the fundamentals (and waiting for information that we had asked for weeks ago)’.

[11:40] FSA’s Head of Actuarial Support comments that there was still ‘the relatively minor issue of pre-75 policies’, that he had alerted Equitable’s Appointed Actuary to it, and ‘would be prepared to let this go if necessary (on the basis that they are being well treated and the cost to others should not be material)’.

[11:56] Chief Counsel A says that she did not think that FSA could give up the issue of the pre-1975 policies but suggests that it was a point that could be resolved during the consultation.

[14:39] Line Manager E informs Chief Counsel A, Head of Actuarial Support and the Head of Life Insurance that Equitable’s Appointed Actuary had just telephoned, having realised that they had made a mistake in relation to the uplift for pre-1975 GAR policies. Line Manager E reports that the proposed uplifts were now in the range of 3% to 7%, which ‘seem much closer to the kind of range that I think [the Head of Actuarial Support] had expected, and should put us firmly back into “best estimate cost” territory’.

FSA write to Equitable, in response to a letter of 13 August 2001, ‘requesting FSA consent for the Society to buy back part of its subordinated debt on a basis that would not require disclosure to the market’. FSA say:

We do not believe that we could justify giving consent for such a buy-back at the present time. As the Society has made clear in its published accounts, there is a fundamental uncertainty surrounding the financial position at the moment. We shall wish to see this uncertainty significantly reduced before giving consent for money to be paid out to those whose interests are subordinated to those of policyholders.

Counsel inform FSA of a discussion with Counsel for Equitable about an objection that had been raised by a policyholder action group.

[20:03] FSA’s Director of Insurance later suggests to the Director of GCD that they should delay questioning Equitable about the issue until the following week as he did not want to distract them from the other very high priority issues that had already been raised with them.

FSA meet Equitable.

According to FSA’s note of the meeting, the agenda was largely driven by the Director of Insurance’s letter of the same day on the issues remaining to be resolved on the compromise scheme before the FSA could decide not to intervene. The points discussed include:

• that Equitable needed to review the presentation of the quantification of mis-selling liabilities to make clear what the legal assessment was and to explain the basis for the calculation that was being used;
• that FSA questioned Equitable’s approach to discounting the potential liability. However, it was noted that this question might be overtaken when FSA received further information from the independent assessment that was being carried out;
• that FSA seek confirmation that the solicitors acting for the non-GARs would not be recommending that the group should be separated into more than one class because of their different legal rights; and
• that: ‘There was a continued concern about the potential difficulties of policyholders seeking to leave the society and bring claims in parallel to the scheme, in a way that would mean that they could avoid meeting part of the cost themselves, although the Society indicated it thought that the risks were unlikely to be sufficiently great (given quantum and uncertainty) to justify the PR difficulties of trying to address the problem by cutting policy values (either by increasing the financial adjuster or reducing terminal bonus further)’.

FSA hope to be able to give a clearer indication of their position by 6 September 2001.

FSA’s main supervisory file includes a note from the Appointed Actuary’s company to Equitable about a question raised by FSA in relation to a draft paper that they had prepared, entitled ‘Assessing Potential Cost if Non-GAR Policyholders Are Deemed to Have Been Mis-sold’ (dated 29 August 2001).

(Note: the paper dated 29 August 2001 was not held on any of FSA’s files.)

The note explains that the draft paper:

… included a table on page 5 comparing asset shares and policy values. This estimated that accumulated Policy Values as at end 2000 were about 95% of Asset Shares looking back across policies sold in the period 1988-2001.

[FSA’s Head of Actuarial Support] subsequently asked for more information, comparing policy values and asset shares year by year. [Equitable] responded on 3 September with the information shown in Appendix A. The ratio of Policy Values to Asset Shares from [Equitable’s] work averages about 88%, compared to the 95% above. [The Head of Actuarial Support] has queried the consistency of these figures.

The Explanation

• [Equitable’s] figures were for single premiums, not regular premiums, and covered only pensions business, whereas the figures in [the Appointed Actuary’s company’s] note included [with-profits] annuities and Life business (ie all [with-profits] Non-GARs, as requested). To eliminate these differences, we have carried out an analysis which looks specifically at regular premium pensions business, and the results are shown overleaf. By inspection, the average ratio is about 89%, which is very close to the figures provided by [Equitable].

• l We have also established that the class of [with-profits] annuity business exhibits different characteristics from the other life and pensions business. For [with-profits] Annuities, the policy value calculations in [the Appointed Actuary’s company’s] note make no cuts in policy values as at 16 July 2001 (compared to cuts of 16% and 14% for pensions and life). We understand this is consistent with what has happened in practice. Because of this, the [with-profits] annuity policy values are actually higher than asset shares. Hence, the aggregate ratio of policy values to asset share increases significantly when this class is included – as evidenced by [the company’s] comparison. (We understand from the Society that it is intended to limit future additions to [with-profits] Annuity policy values in order to achieve a similar effect to the cuts already implemented for the other classes of business.)
• There are other smaller differences in the approach taken between the two sets of figures, but the explanations above are the most significant, and we believe they provide a suitable reconciliation.
• Please note that whichever set of figures is used has little bearing on the rest of [the company’s] paper. That paper concentrated primarily on comparisons of ELAS against its peers. In particular, the comparisons of payouts used an entirely different data source. The paper did not make any market comparisons for [with-profits] annuities, as we have not seen any reliable data to do so.

Legal Adviser F advises the Director of Insurance and the Director of GCD as to whether there were alternative sources of directors’ and officers’ cover for Equitable’s Board (see 23/08/2001 [entry 4]).

The Director of Insurance comments to the Head of Life Insurance ‘Not much help here!’.

FSA write to HMT, further to their letter of 17/08/2001, setting out their views on the relative advantages and disadvantages of administration and provisional liquidation of Equitable should the company consider that they could no longer continue without seeking the protection of the court. FSA say that their view, supported by Halifax and Equitable, was that there was significant advantage in administration and that the arrangements should be put in place, at least on a contingency basis.

FSA explain that insurance companies could not currently be placed into administration and, as a result, the practice of provisional liquidation had developed instead. FSA say that there were significant presentational and substantive disadvantages in provisional liquidation, with the presentational factor being the most compelling.

On the presentational advantages of administration, FSA say:

In the situation faced by the Equitable a compromise scheme under S425 of the Companies Act seems clearly to offer the best outcome for policyholders. While this could be promoted by either an Administrator or a Provisional Liquidator, there can be little doubt that promotion of such a scheme by an Administrator, whose very purpose is to achieve the continuation of the business, would be perceived very differently by policyholders than the appointment of a provisional liquidator, notwithstanding that he could also promote such a scheme.

On the substantive advantages of administration, under the heading ‘Continuity of annuity payments’, FSA say:

There are some 139,000 Equitable life annuities in payment at present. Continuity of these payments, which for many pensioners will represent a significant proportion if not all, of their income, is therefore a significant issue. While, absent resolution of the Article 4 issue, there must be significant doubt as to whether either an Administrator or a Provisional Liquidator would be able to continue such payments without the explicit leave of the Court the position of an Administrator is likely to be somewhat more flexible in this respect since the current draft Order under FSMA 2000 s.360 specifically empowers the Administrator to make payments falling due as distributions on account of the policyholder’s anticipated distribution in any eventual insolvency.

FSA argue that there are procedural and cost advantages in using administration. The third substantive advantage given is that administration was reversible. FSA state:

The solvency of a company carrying on long-term assurance business is a matter of judgement about future events rather than an empirical fact.

The Equitable is subject to the uncertain costs of providing GAR benefits and of compensating non-GAR policyholders, who might have been entitled to better warning of the GAR risks. If excessively cautious views are taken of these costs now, and if a s425 scheme cannot be put in place liquidation might be unavoidable, with very significant damage, disruption and cost. However, in the longer term these costs might prove less than feared. If so, the company could be restored to solvency. In practice, it is very difficult to see winding up proceedings, once commenced, being reversed. Administration, by contrast, is designed to provide temporary protection and is intentionally reversible.

FSA outline what they saw as the presentational and substantive disadvantages of administration, both of which were linked to not undertaking a period of public consultation on the legislation before it was made. FSA say that these disadvantages did not outweigh the advantages.

FSA speak to Equitable and put the question to them: ‘Have you been advised that you can legally calculate uplift not merely on contractual entitlement but also on the non contractual element of policy values, even if this could mean that uplift is not based evenly on legal entitlements? eg two people with the same legal entitlement get different uplifts because policy values have different non contractual elements?’.

The question emanated from an objection to the compromise proposals from one of the policyholder action groups.

Line Manager E provides FSA’s Chairman and Managing Director B with a paper on the compromise scheme. The paper states that FSA needed to consider:

a) whether to exercise formal powers to intervene

1.  to stop the Society going ahead;
2. to require it to modify its proposals
3. requiring it to modify the presentation of its proposals,

b) the FSA’s public position about the scheme and the issues arising,

c) what the FSA should publish at the time of the launch on possible mis-selling by Equitable and on the wider implications for the industry.

The paper continues under the following headings.

Objectives

It is noted that FSA had said publicly that they saw a compromise scheme as being ‘a positive way for the Society to resolve its difficulties’ and, therefore, that they were keen to see a ‘decent’ scheme adopted. Line Manager E says that FSA needed to ensure that their approach ‘best meets the interests of policyholders, the Society and the wider industry in a way consistent with the FSA’s statutory objectives’.

Timing

It is noted that FSA needed to indicate their position to Equitable before the Board meeting planned for 7 September 2001, while noting that ‘In deciding what to do now, we need to bear in mind the stance we may take later’.

Recommendations

Line Manager E writes:

If we considered that the scheme being proposed was unfair or unreasonable, we would need to consider intervening to stop the consultation. However, subject to the satisfactory resolution of the outstanding issues relating to mis-selling liabilities, which are fundamental to the whole package, we do not consider that there are any substantially unreasonable elements of the proposed scheme to which we ought to object. We should not therefore use our powers to prevent the Society going ahead with the consultation, or at this stage to require it to modify the proposals on which it will consult. (N.B. we do not need to determine that there has been mis-selling. The mere fact that leading Counsel will have opined that there is a substantial risk of successful claims is enough to make it reasonable for the Society to compromise these.)

The paper continues:

The only circumstances in which we believe that it would be appropriate to compel changes to the documents would be:

a) if they were misrepresenting the position of the FSA or its legal advisers; or

b) if they gave a misleading picture about the scheme or the position of the society (for example by overstating the legal uncertainties on mis-selling or giving a misleading impression about the financial position before or after the scheme, or simply by omission).

FSA state that they did not consider the information to be misleading or that it misrepresented their position. They set out the public line that should be taken:

It is not the FSA’s role to design the scheme, but rather to consider whether the scheme devised by the Society is acceptable to the FSA and whether it is appropriate to exercise any of the powers available to us, including seeking to make representations before the court.

Basis of FSA’s powers

The paper sets out the powers under which FSA could intervene in the compromise scheme deriving from ICA 1982, FS Act 1986 and the PIA rulebook. FSA state that the basis on which they would be likely to intervene would be that: (a) the launch of the consultation, whether because of the substance or the presentation, would of itself be damaging (or potentially damaging) to the interests of policyholders; or (b) the scheme had little prospect of success and that the launch of such a scheme could itself be damaging.

Our position

The paper reiterates FSA’s stated view that such a scheme was the best way for the Society to overcome its difficulties, noting:

The FSA’s support for a scheme on this basis would provide a degree of confidence that may well encourage policyholders to vote in favour. However, that could be undermined if we were seen to have been too ready to accept the Society’s approach or if we were to change our position in the future, which we might in the light of the consultation. Such a course of action could also cause wider damage to confidence in the FSA and the system generally.

The scheme proposals

The paper explains the proposals for the scheme that had been put forward under the sections ‘The GAR Scheme’, ‘The non-GAR scheme’ and ‘The combined scheme’.

Other views

The paper notes that Halifax and the independent actuary for the scheme had had similar concerns to those expressed by FSA, particularly on presentational issues.

FSA’s Chief Counsel A informs the Head of Actuarial Support that Counsel was happy to meet with the Independent Actuary for the compromise scheme to answer any questions about his and Counsel for Equitable’s opinions. The Chief Counsel asks him to let the actuary know.

The following morning [at 08:58], the Head of Actuarial Support says that he would be interested in attending such a meeting ‘so that we can begin to make some sort of sensible quantification of the balance sheet provision’. [12:17] Chief Counsel A says that he saw no reason why the Head of Actuarial Support should not attend a meeting.

The actuaries conducting the mis-selling review send FSA’s Head of Actuarial Support an updated paper.

(Note: the paper that was sent was not held on any of FSA’s files.)

FSA’s Chief Counsel B circulates a draft statement, ‘Equitable Review and Redress: Comparing the Compromise Scheme and Individual Redress’, further to the one prepared on 30/08/2001 [16:41]. Chief Counsel B says that he thought that such a statement: ‘needs to be quite explicit about what is involved and needs to acknowledge the point that in any individual claim brought by way of litigation or, perhaps through the Ombudsman, there would be no discount to reflect the uncertainties of litigation. This is something which I think goes to the reasonableness of the compromise’. The Chief Counsel suggests that the statement could be discussed at the daily round-up meeting.

The statement reads:

The FSA is aware that policyholders assessing the merits of the Society’s compromise proposals may wish to gauge what their position might be if, instead, the FSA were to take action with a view to ensuring that … the Society paid compensation to all those to whom it may be due in consequence of the mis-selling of non-gar policies. One option available to the FSA would be to require the Society proactively to review the sale of all policies to non-gar policyholders. This would involve examining in each case the probability of there having been a failure to provide the policyholder with information or advice sufficient to meet the regulatory standards in force at the time and whether the investor would have been likely to have acted differently had adequate information and advice been provided. It would also be necessary for the Society to examine in each case whether the policyholder has as a result suffered financial loss. Such a proactive review would not necessarily result in compensation or significant compensation being paid to all non-gar policyholders.

In the FSA’s view, based upon the legal advice which it has received, the amount of compensation which is likely to be due in the majority of cases would be based upon  a comparison between the current value of the Society’s policy and the value of a comparable policy from another provider. This comparison could conveniently and appropriately be made by reference to a suitable industry average return. The FSA’s advice is that in most cases it would be likely to be necessary to restrict compensation  to an amount which is no greater than that attributable to the impact of the Society meeting the full cost of the GAR policies in accordance with the decision of the House  of Lords’.

It appears that the Society has broadly followed these principles in its compromise scheme proposals. However the scheme also proceeds on the footing that, rather than cash compensation, policyholders should accept an adjustment to their policy value in return for giving up mis-selling claims relating to the cost of meeting the gar policies. The value of the proposed adjustment is discounted to take account of an estimate of the chances of mis-selling claims succeeding and also the probability that the economic impact of compensation would in any event fall to be borne (to the extent of 73%) by non-gar policyholders collectively. On the basis of the present proposals this leads to the Society placing an overall value on the potential mis-selling claims of [£846m] which after applying the discounting factors is reduced to [£400m]. This sum would then be applied to produce an uplift of 2.5% across all non-gar policy values.

If instead the Society were to examine individual cases and pay compensation where it is due, on the same principles, the compensation amount would not be substantially different but would obviously not fall to be adjusted by reference to the chances of the claim being successful and nor would there be a deduction to reflect the economic impact that non-gar policyholders as a class will have to bear (being a significant proportion of the costs incurred by the Society in meeting such claims). There would however be some commensurate economic effects on non-gar policyholders. For example, the institution of a systematic review of policies would be very likely to lead to a reduction in current policy values and the amounts which in the future would be available to the Society to distribute by way of discretionary bonus. Both would be reduced by the amounts paid out by way of compensation and by the provisions which the Society would be obliged to make.

Policyholders would therefore be wrong to conclude that the compromise proposals would necessarily involve them being treated in a significantly less advantageous way than if their cases were individually considered as part of a proactive review of individual cases. In particular policyholders should not view the proposed discount to reflect the fact that non-gar policyholders could pay 73% of the claims as being inconsistent with the overall result if they were successful in pursuing an individual claim. As is explained elsewhere, the FSA acknowledges that in any compromise of this kind there will inevitably be trade off between the potential and uncertain value of claims which might otherwise be successfully pursued and the amount available by way of compromise. In the opinion of the FSA the proposal in the scheme to discount the value of the policy uplift by a further factor to reflect the uncertainties of litigation is a factor which falls within what is a reasonable range of possibilities and is a figure on which it is appropriate for the Society to consult.

Equitable’s advisers for the compromise scheme send FSA the latest versions of the compromise scheme documentation.

[18:30] Following FSA’s daily round-up meeting [at 17:00], FSA’s Head of Life Insurance says that it had been agreed that there remained an issue regarding claims from policyholders who had left, or who might leave, before the compromise scheme came into effect. The Head of Life Insurance notes that it had also been agreed that they would review the relevant parts of Counsel for Equitable’s opinion over the weekend and would meet on Monday to discuss, before putting the issue to Equitable at the meeting planned for 11/09/2001.

[22:09] In reply, Chief Counsel A writes:

Unfortunately (and sorry if I am stepping on your toes [Chief Counsel B]) it rather looks as though we will need to be ready (at a minimum) to say that we disagree with the basic principles for compensation outlined at pages 13 and 20 of the Background [document], while acknowledging that it is possible that nevertheless, on the [Counsel for FSA’s] theory, we could end up at the same point or near it (or could we – see paras 5.2.1 and 5.3?). Or does anyone think we should recommend to [FSA’s Chairman] that we should intervene? My first instinct is to say not, because the issue will be clear to many once the Opinions are published (and accordingly transparent for the purposes of the consultation). Should we go back to [the Chairman] in any event?

FSA’s Head of Actuarial Support writes to Counsel, having given some further thought, following their discussion that afternoon, to the issue of redress for non-GAR policyholders. The Head of Actuarial Support sets out his understanding of the position to be:

1) If a Court were to award damages to the non-GARs, then this would most likely take the form of a cash payment equivalent to the loss in “policy value” sustained by the non-GAR policies. This would have a potential aggregate value of around £850 million if it were based on the “loss” of final bonus last year, or around £200 million if it only took account of the “loss” of the 4% declared bonus that might have been awarded in the absence of the [House of Lords’] judgment.

2) This cash payment would reduce the amount of assets available to fund the potential final bonuses to non-GAR policyholders. This means that in principle, all policy values might be cut by around 4% (though I acknowledge that there is a separate issue lurking around about whether it is justifiable to base these reductions on the total policy value and thereby for example have “policy values” for more recent policies that are below the guaranteed funds). Accordingly, the non-GAR policies would gain an immediate cash payment but lose some potential final bonus.

3) Another consequence would be that the “free reserves” on the balance sheet would be reduced as well by the £850 million cash payment. Therefore, there would be an increased risk of insolvency which would of course have an adverse effect on all continuing policyholders.

4) Under the proposed compromise scheme, the non-GAR policyholders will instead receive a combination of a 4% guaranteed bonus addition to their basic benefits (or 0.5% for those who have already received a 3.5% “guaranteed investment return”), together with a 1.5% increase in policy values (plus a further 1% in respect of the Halifax money). The effect on the balance sheet for in-force policies (ie before considering the more difficult issue of those who have left or may leave before the compromise scheme is agreed) is expected to be a reduction in free reserves of around £200 million in respect of mis-selling costs (ie the value of the above guaranteed bonus).

5) It is very difficult then to make a direct comparison of these two alternatives (namely the cash payment or the compromise scheme) as they have a slightly different effect on (a) the guaranteed benefits, (b) the potential final bonus (and hence payouts) and (c) the balance sheet (and hence the risk of insolvency).

6) This does all though highlight the problem that a significant number of policyholders may elect to leave before the scheme is approved, either on a contractual date (if available) or by taking early surrender (when they would be subject to the financial adjuster). These policyholders would then have the possibility of obtaining a cash payment by way of damages without suffering a loss in their benefits (unless the society now reduces either the final bonus or the financial adjuster and the policyholder cannot then claim for additional damages as a result of this change).

Further to Chief Counsel A’s comments of 06/09/2001 [22:09], FSA’s Head of Life Insurance says that he thought Equitable were ‘quite clear and transparent about the legal advice, and how they had reached their basis for compensation; and that on this basis we would not be justified in intervening’. He arranges a meeting with Managing Director B at 11:30 to discuss this.

[11:32] Chief Counsel B provides a summary of the outcome of a discussion between legal advisers, which was subsequently agreed by Counsel. The Chief Counsel says:

We doubt very much whether there is a fundamental problem which should cause us to object to the publication of the document. But it is [a] great pity that the Equitable has expressed itself in this way.

The problem is that the drafting leaves room for the gars to conclude that the non-gars have not suffered any financial loss. On this basis the gars might well question the basis for offering any compromise to the [non] gars.

It would be preferable if, notwithstanding the qualifications the Society were to say in plainer terms that … on the basis of Option 3 it is satisfied that the non gars have suffered a degree of loss which is at least as great as the transfer of value. This is we understand (but could [FSA’s Head of Actuarial Support] please confirm) where the [Appointed Actuary’s company’s] analysis leads and is in any event supportable by comparing the option 1 finding with option 3 (the with profit fund has in general terms performed as well as competitors but pay outs for non gars are materially less than for comparables (subject to the qualifications)).

FSA’s Head of Life Insurance informs other officials that Equitable had confirmed the previous evening that no further work had been done on the independent report into their financial position, commenting that: ‘This is Equitable’s response to my request for a final version of the “draft” notes left with us by [the Appointed Actuary’s company] on Equitable’s financial position. We can take those notes as now final’.

[11:58] The Insolvency Practitioner suggests: ‘I think we should ask for a copy of the report without “draft” stamped all over it but should accept that it might come with a covering letter from [the Appointed Actuary’s company] saying that the work we asked for on sensitivities has not been done (and any other caveats [that the Appointed Actuary’s company] think appropriate). In other words, we will not put the Society to the expense of more work on sensitivities since although that would be useful it is not essential; but we do need something which can be held up to scrutiny as the basis for the FSA saying that it relied on it as comfort that the Society was solvent’.

FSA’s Insolvency Practitioner provides the following comments on the updated paper on mis-selling quantification (see 06/09/2001 [15:37]):

(1) I would still like to capture enough information to work out how much non-GAR misselling claims might be limited by the £48,000 cap under the PIA indemnity scheme. Can we follow this up once the launch document is out and things are less frantic. Better to have information available should the stock market falls leave the Society exposed to solvency issues.

(2) It’s still difficult to get a grip on the quantum of misselling liabilities without knowing how much is paid in premiums year by year: ie what weighting do you give the % shortfalls for investments made at different times? However, this seems a second-order consideration.

(3) I think they might have double discounted the presumed over-declaration of bonuses in the industry: ie … they illustrate a reduction in the Society’s policy values of 10% (presumably he 16% reduction on 16 July less a presumed 6% reduction yet to filter through in the industry). This produces % differences for monthly premiums of -4%, -8% and -11% for 5, 10 and 13 year terms. The table at the bottom of page 11 then produces a weighted average of these % differences combined with single premium % differences. The result is -6%, -11% and -12%. However, they then go on to discount the effect again on page 12 producing weighted averages of -2%, -6% and -7%.

Thus, I think the true position is that the misselling liabilities are significantly above the GAR cost (of 5%).

(4) We then need to consider what value to give the “unique flexibility” of the Society’s policies. The way I see this, the flexibility is the ability to retire between a wide range of dates. For some policyholders, retirement flexibility will be irrelevant to their circumstances and therefore they would attach no value to this option. For others, particularly the self employed I would suggest, this would be a crucial feature – so much so that they would be likely to remain with the Society even if they knew of the GAR risks if there truly is no comparable product on the market. In which case they would be hard-pushed to demonstrate a loss because they would not have followed a different course of action. I think policyholders will fall into one extreme or the other – at which the “flexibility” of the product has little value. Thus, I do not think that there should be much discounting of the misselling liabilities because of this product feature. ie the misselling liabilities will remain above the GAR cost and the “[Counsel for FSA] cap”.

My conclusion is therefore that the [Appointed Actuary’s company’s] work supports the approach taken by [Chief Counsel B] in his excellent note of 6 September: a draft statement which the FSA could make following the launch document to the effect that policyholders should not expect more or less than is offered under the scheme were they to seek individual redress, (predicated on the assumption that compensation would be capped by reference to the GAR cost).

FSA meet the Financial Ombudsman Service to ‘bring them up to speed on the issues surrounding Equitable Life’. FSA’s note records:

[The Financial Ombudsman Service] said that they had just over 400 complaints about misselling by Equitable (these were “converted” cases, which had been accepted as complaints for [the Financial Ombudsman Service] to deal with). Most complaints related to a period during and after the litigation, and were from non-GAR policy holders who complained that their potential exposure had not been disclosed. [The Financial Ombudsman Service] had “parked” these complaints, on the basis that it was not sensible to deal with them while other enquiries (such as the FSA’s independent enquiry) were proceeding. They were keen to continue to put on hold applications in the pipeline, and to dissuade new claimants coming forward, until there was a clearer basis on which to decide on how to proceed.

FSA also record that:

[The Financial Ombudsman Service] suggested that the normal basis for compensation should be repayment of premiums plus interest. We commented that this may be a possible appropriate remedy for those who had taken out policies very recently; but it was not appropriate for longer term policies, and therefore would not be suitable as a basis for an across the board settlement.

FSA’s Head of Life Insurance asks Chief Counsel B if he could send Equitable the latest part of Counsel’s opinion on grossing up. The Head of Life Insurance explains that Equitable were worried by what their Counsel had said on this point and that they were hoping to get a different opinion from other Counsel.

The Head of Life Insurance says that a change to the compromise scheme launch documentation requested by Equitable had been accurate, but asks whether it went far enough to meet FSA’s concerns. He says that the point in question was to the effect of: ‘The starting point for fair value compensation for non-GAR policyholders as a group, is a comparison to industry payouts. There are practical difficulties with this approach, and these are discussed in section [5] (of the background document)’.

[16:14] Chief Counsel B replies that he believed FSA could ‘live with’ Equitable’s description of the principles for compensation.

[19:41] FSA inform Equitable that they did not regard the statement as ideal but note that it was factually accurate. FSA also confirm that they had no issue with two other amendments to the documentation.

FSA’s Chief Counsel B writes to the Head of Life Insurance about a request from the Guernsey regulators on 7 September 2001 to have sight of Counsel for FSA’s opinion on mis-selling.

[11:03] Line Manager E tells Chief Counsel B that he had been ‘thinking about what we needed to do about alerting other regulatory bodies. To a degree, [Counsel for Equitable/Counsel for FSA] may not be very relevant to them – since they relate to issues that do not directly affect Guernsey, Germany or Ireland’. The Line Manager notes, however, that there were wider issues relating to the compromise scheme and suggests that the best approach might be for Equitable to provide advance copies of the advice to their regulatory supervisor in those countries. Line Manager E also suggests that FSA could provide the other regulatory bodies with a copy of their question and answer briefing note.

An FSA official circulates the latest version of FSA’s information sheet ‘Questions and answers about Equitable Life’. The official explains that amendments had been made to paragraphs 7 (‘What has the FSA done to regulate Equitable Life and to protect policyholders?’) and 11 (‘Is the Government going to step in if Equitable Life becomes insolvent?’), and that paragraph 9 (‘What about the Independent Inquiry?’) had been added. The official asks for comments.

The Head of Life Insurance suggests some amendments the following day.

FSA and Equitable get together for their weekly meeting to discuss latest developments. FSA’s record of the meeting includes the following.

Quantification of mis-selling liabilities is discussed and it was ‘noted that much turned on whether Equitable’s salesforce had given advice’ and it is ‘accepted that the “advice” given by the tied sales force … was probably not “advice” in the sense used by our respective Counsel, although the intention was that advice claims (if any) would be bound within the terms of the scheme’. FSA question whether Equitable’s approach was reasonable when there was no clear statement of the value that was being given up in exchange for the right to pursue mis-selling claims. Equitable say that they, and their Counsel, were ‘comfortable that the offer was a commercial judgement within what they had calculated to be a reasonable range for compensation if it went to litigation’.

Equitable recognise that they would have to deal with the potential liabilities in their Companies Act half-year accounts and in their regulatory returns. FSA record that Equitable had ‘discussed with the audit partner and they were minded to include a figure based on the amount taken as the starting point for the scheme (ie £850 million), with appropriate notes to explain the uncertainty’.

FSA raise the question of whether return of premiums plus interest could be used as a basis for compensation for more recent sales. Equitable express doubts about the validity of such an approach, but agree that the issue should be considered by their Counsel.

FSA ask ‘if the Society had any further thoughts about the possibility of seeking to prevent policyholders leaving the with-profits fund and taking their mis-selling claims intact’. Equitable’s Chief Executive ‘noted the difficulties, and said that they had not seen a way to solve the problem. He had been advised that it was not possible to ask policyholders to waive all their rights if they surrendered because of the Unfair Contract Terms regulations. He agreed that an increase in the MVA was a possibility, but that was unfair in that it attacked those surrendering early while those with maturing policies got away without penalty. They agreed to consider this further, but they thought the risk of taking action were likely to be too great compared with sitting tight. (They noted that with markets falling below 5,000, the cover currently provided by the 7.5% adjustment was thin)’.

FSA say that they would expect Equitable to speak to the Guernsey, German and Republic of Ireland regulators.

FSA ask if Equitable could ‘arrange for the presentation from [the Appointed Actuary’s company] to be finalised’, to which they agree.

Equitable mention that Standard & Poor’s had announced an intention to issue a temporary downgrade of their rating for the company when the compromise scheme documentation was published. FSA ‘made it clear that we were not in a position to influence [Standard & Poor’s] but agreed that the announcement would not be helpful’.

FSA’s Chief Counsel B responds to the Director of Insurance’s note of the previous day about the publication of FSA guidance on mis-selling. The Chief Counsel puts forward suggestions as to how this could be done.

PIA also offer some comments.

While prioritising his work, Line Manager E uncovers a message about Equitable’s request for a future profits implicit item for possible use in their 2001 returns. The Line Manager asks Scrutinising Actuary F whether either of them had asked Equitable some of the questions and whether the ‘ball is currently in their court’.

[17:22] Scrutinising Actuary F explains that he had asked the question on 19/07/2001 and had received a reply on 20/07/2001 and, as the reply had not been sufficient to give FSA the comfort they required, he had written again on 21/08/2001. He suggests that one of them should chase Equitable for a reply.

[17:31] Line Manager E says that he thought that the Scrutinising Actuary was on the case, and that:

As for chasing, I am not inclined to do much – there will not be much enthusiasm on 7th floor for approving the recommendation to the Treasury (or for FSA to sign off on a waiver post [FSMA 2000 coming into force]) just at the moment, and lets face it, if the Society does not provide the information, we cannot process the application. I am not around after this week, until 3rd October, so perhaps we can take it up then if you have not heard in the meantime.

FSA’s Head of Actuarial Support informs officials of a telephone call from Equitable, saying:

I have just spoken with [Equitable’s Appointed Actuary] who tells me that Equitable are about to increase their financial adjuster from 7.5% to 10% in view of recent market moves …

Regarding their overall solvency, [he] believes that their margin of solvency will remain covered (albeit with a fairly low mis-selling provision) as long as the FTSE 100 remains above 4500. (I understand that Companies Act solvency would similarly be maintained down to around an index level of 4000).

[15:39] In response to Line Manager E, the Head of Actuarial Support understands that ‘about to’ meant mid-afternoon that day.

[16:18] Line Manager E reports that the announcement had been made at 16:00. The Line Manager says that he had checked FSA’s fact sheet, which did not mention the market value adjuster, and he suggests that FSA’s website might be in need of updating.

FSA’s Head of Insurance Policy circulates a report by a tax expert on major tax issues related to Equitable going into administration, liquidation or being wound up. The conclusions reached by the report are:

The likely options for [Equitable] can be broadly divided between those which fall short of a “stop order” on a winding up, and following such an order. Up to that cut off point, the tax impact is low key. Following a stop order there would be a significant tax impact on both [Equitable] and most policyholders (who would be creditors at that point).

The Revenue do not appear willing to offer any concessions with the policyholders’ tax position on a winding up, which seems unduly harsh.

Winding up a mutual life office is untested in tax terms, and certainty cannot be achieved. However, the conclusions are likely some 95% certain post a stop order, and somewhat less at some 75% certain prior to that point.

FSA write to Equitable to finalise the formalisation of the monthly reporting requirements. FSA query whether they had received an answer to one suggested change.

[21:54] Equitable confirm that they would make the change going forward and promise to get back to FSA on whether they would be able to provide certain separate information on GAR and non-GAR policies.

FSA speak to Equitable, who provide them with a copy of Counsel’s opinion, dated 21 August 2001, on:

… a point relating to damages for alleged mis-selling.

The following assumptions are not apparently in dispute:

• A is a non-GAR who has a claim for 100.
• The Society … is liable to A for 100.
• [Equitable] can recover 100 from members as a whole, including GARs and non-GARs.
• Such recovery can take the form of withholding bonuses and in the case of mis-selling litigation is likely to do so.
• A very large number of policyholders, being all the non-GARs, have similar claims to A.

The question in dispute is whether each of the non-GAR members from whom bonus is withheld can claim the amount of such withheld bonus as further damages from [Equitable].

The opinion given is that ‘[A non-GAR policyholder] cannot claim as part of his damages the loss suffered by him as a result of mis-selling to the other non-GARs’ (subject to some possible exceptions).

FSA note that Equitable had also just received Counsel’s opinion on the proposed compromise scheme and that Equitable promised to send FSA a copy, which Equitable subsequently do.

The opinion, marked ‘draft 13 Sept 2001’, includes Counsel’s view on whether the classes of creditor to be summoned to vote in meetings on the proposed scheme had been correctly constituted. In relation to GAR policyholders, the opinion states:

Each GAR policyholder has different rights under his policy. But there are groups of GAR policyholders with similar GAR rights. These groups are those with GAR rights calculated on a similar interest rate basis and those with the ability to choose a flexible form of GAR annuity. The value of GAR rights will vary depending on which group the policyholder falls in and it is proposed to vary the uplift for each group accordingly. The value of the GAR rights will further vary with the age of the policyholder and the uplift within certain of the groups will also vary accordingly. The result is that GAR policyholders will receive [an] uplift in an amount which equals an actuarially justifiable estimate of his GAR rights.

On [that] basis we are of the opinion that there is a reasonable prospect that the Court will be satisfied that GAR policyholders form a single class.

In relation to non-GAR policyholders, the opinion states:

We have previously expressed the view that, in relation to non-GAR policyholders, the issue of class determination is more difficult …

In particular, as appears from [the Society’s Counsel’s opinion], non-GAR policyholders have several different potential mis-selling claims with a very wide range of merits. We anticipate that a credible challenge to the constitution of the non-GAR class could be made by a dissenting non-GAR policyholder who presented evidence to the Court that he had a claim against the Society with a very high likelihood of success. The policyholder would argue that he is not in the same class as, for example, a non-GAR policyholder whose policy was purchased before 1980 and whose claim had virtually no prospect of success.

On this basis we initially expressed the view that it would be preferable to offer a percentage uplift to all non-GAR policyholders which varied with certain important aspects of their claims. This would be similar to the variable uplift proposed for GAR policyholders. We were subsequently informed that a scheme which sought to offer differential percentage uplifts to non-GAR policyholders is not likely to be supported by the requisite majority of creditors. In view of the fact, and considering a number of other matters relating to the reasonableness or otherwise of a flat percentage uplift to non-GAR policyholders [As set out in paragraph 7 of the Joint Note], we expressed the view and continue to be of the view that the court is likely to be satisfied that the classes have been correctly constituted.

FSA’s Press Office circulate the latest drafts of a press statement to be made by FSA on the proposed compromise scheme and the question and answer briefing.

[21:33] Chief Counsel A suggests some amendments.

FSA’s Insolvency Practitioner suggests to Line Manager E, the Head of Life Insurance and the Head of Actuarial Support that FSA should ‘emphasise, and enforce’ their need for information on policy values and terminal bonus to be properly provided by Equitable in the monthly financial reporting. The Insolvency Practitioner notes that Equitable had not provided the required information in June and July and were thus in breach of the section 45 Notice issued.

The Insolvency Practitioner estimates that policy values were currently 10% too high.

FSA’s Director of Insurance circulates a proposed FSA statement ‘Reviewing Guaranteed Annuity Business and With-Profit Disclosure’.

[13:41] Chief Counsel A provides drafting comments.

Line Manager E sends FSA’s Chairman copies of FSA’s proposed statements, press lines, guidance and question and answer briefing on the compromise scheme.

[20:09] Chief Counsel A provides a revision to the suggested answer to the question: ‘How could you have allowed mis-selling to go on for so long without doing anything about it?’. The suggested answer reads:

It has only been possible now (following the clarification of the Equitable’s legal position by the House of Lords) to form a provisional view about whether policies sold to non-GAR policyholders have been missold. Some 6000 out of [26,000?] policies were sold following the [House of Lords’] judgement. Those non-GAR policyholders are included in the compromise scheme. The regulators judged at the time that the closure of the Equitable to new business immediately following the [House of Lords’] judgement would have prejudiced its chances of finding a buyer – where a sale would, of course, have injected money into the fund.

Equitable’s Appointed Actuary sends a letter to FSA’s Head of Actuarial Support (copied to their auditors), informing them of the existence of a side letter to the reinsurance treaty. The Appointed Actuary explains that Equitable had:

… sought legal [advice] on implications of this side letter, and they are unclear, although we are advised that the side letter is arguably of no effect.

So shortly after the terrible events in America, you will appreciate that the reinsurance parent company is fully stretched managing its exposure. We have received a written indication that the Irish European Reinsurance Co Ltd and its parent want to find out clarification that removes any doubt as to the implications of the side letter.

FSA’s Head of Life Insurance sends Chief Counsel B a note about a telephone conversation that he had had with Equitable. The Society had told him that it could find no evidence that Equitable had modified their sales literature after the House of Lords’ ruling. The Head of Life Insurance records:

[Equitable’s Finance Director] was concerned about this; but he also remarked that he could find no evidence that the FSA had required any modification to the sales literature. He asked me what the FSA had done in this regard. I said that I did not believe that the FSA had put any specific requirements on Equitable Life with respect to its sales literature after the House of Lords’ judgement …

The Head of Life Insurance tells Chief Counsel B that he had spoken to PIA about this who:

… confirmed my recollections. PIA had visited Equitable just before the House of Lords’ judgement in June, and did not raise the question of the consequences of the House of Lords’ judgement, as they understood that Equitable were working on that themselves. After the judgement, the view was that the Equitable was solvent, that they were likely to succeed in securing a buyer, and that therefore there was no reason why they should not go on selling. But it was the Equitable’s responsibility to ensure compliance with the PIA rules at all times.

The Head of Life Insurance says:

I do not know why [the Finance Director] asked about the FSA’s position but I am inclined to be cautious in responding to him. My inclination is to go back to him in writing to say that insurance companies are responsible at all times for ensuring that they are compliant with PIA rules; this applied to the Equitable after the House of Lords’ judgement just as much as any other time; and that companies should not expect the FSA to tell them when they need to modify their sales literature.

The Head of Life Insurance later notes that he had replied to Equitable along the lines set out in the paragraph above at a meeting on 17 September 2001.

An HMT official provides advice to the Economic Secretary to the Treasury on the advantages and disadvantages of proceeding with the consultation on administration for insurers, in the light of recent events. The advice includes that HMT:

… do not believe that recent events have altered the pros and cons of proceeding with the consultation. Although [Equitable] raised the financial adjustment penalty on with profits policies surrendered early from 7.5% to 10% on Wednesday, its financial position has not been weakened in a substantial way by the events of this week.

FSA send Equitable a copy of their draft question and answer briefing paper and ask for their consent to provide it in advance to the Financial Ombudsman Service and to the Guernsey regulator.

FSA also ask for consent to publish Counsel’s opinion, for the reasons discussed at their meeting the previous day.

FSA’s Head of Life Insurance later [at 11:03 and 18:13] circulates internally the draft briefing, noting that there remained particular sensitivity over questions about sales after the House of Lords’ decision and on solvency.

[22:05] FSA’s Head of Press Office asks the Head of Life Insurance if FSA knew what the Independent Actuary would say on 20 September 2001.

FSA’s Chief Counsel B asks the Head of Life Insurance and the Press Office that it should be made clear in FSA’s press statement that FSA were publishing Counsel’s opinion pursuant to section 206 of the FS Act 1986.

[12:00] The Head of Life Insurance asks, if FSA published under the powers of that Act, whether they still needed Equitable’s consent to do so.

[17:09] Chief Counsel A highlights several ‘awkwardnesses’ with this. She explains that some of the information contained in the opinion had been acquired under ICA 1982 and some while HMT had still been the direct regulator. Chief Counsel A says that the gateway for disclosure was limited and it would be better if Equitable consented to the publication of the relevant material.

An official from FSA’s Press Office outlines the timetable of announcements to be made by Equitable over the coming days and suggests what FSA needed to do in response.

[14:24] In reply, FSA’s Chairman offers some ‘cautionary thoughts’, arguing for less media exposure for FSA. The Chairman says:

1) The Equitable may have made mistakes in the scheme of which we are unaware. They always have before.

2) They may come out with statements/announcements which surprise us. They regularly do.

3) The scheme may change before it goes final. We can’t be seen strongly to back one, then strongly back another which has changed significantly.

4) There may well be stories to the effect that ELAS want to sue us/our predecessors. We know [Equitable’s legal advisers] are briefing policyholders and they won’t tell us what they will say, though I can’t believe they don’t know. So it would look odd if we were too close to them.

5) We will be asked questions about other firms, which we don’t want to stimulate, and to which we have no good answers.

6) We will be asked about our report, about which we can say nothing useful at this stage.

The following day Chief Counsel A comments: ‘Sage advice’.

Further to 05/09/2001 [13:13], PIA query with FSA whether there had been any developments on the guidance provided to independent financial advisers. PIA say:

There was an article in the press last week which reported that [Independent Financial Advisers] are refusing to give advice because they are unsure of the stance we are taking. They are effectively saying to consumers that the policyholder has to make up their own mind about what to do. This reaction is causing concern among some policyholders because we are directing them to [Independent Financial Advisers] for advice but they are then being told that they can’t have that advice.

PIA say that they:

… think this is a tricky position for us to be in. Your comments would be appreciated. And you may remember that [Managing Director A] was keen to issue something.

Further to their reminder the previous day (see 18/09/2001 [17:12]), PIA say that the unanswered correspondence to them from the Association of Independent Financial Advisers was now ‘embarrassingly stale’. PIA continue: ‘Given that the compromise proposals land on policyholders’ doormats tomorrow we really must, I think, have something coherent to say to [the Association of Independent Financial Advisers and the Independent Financial Adviser] community on the contact centre etc. – they will be calling!’.

[10:21] FSA ask for the question and answer material to be recirculated so that it could be agreed and used by both FSA and PIA in response to queries from advisers.

[19:22] PIA recirculate the briefing with an added question in relation to the compromise scheme.

FSA’s Head of Life Insurance informs officials that Equitable were still working on whether they would give their consent to FSA for publication of their legal advice.

[09:24] Chief Counsel B adds that he had been speaking with Equitable’s solicitors, who had provided a form of words designed to allow Equitable to maintain their legal privilege.

Further to a telephone conversation that had taken place, Equitable write to FSA seeking confirmation that they had no objection to the Society buying back 10% of the £350m subordinated loan at the current price of between 51p and 55p per £1 nominal. Equitable say that FSA:

… had asked that we defer until the [Appointed Actuary’s company’s] work was available. That has been completed and we continue to more than meet the [required minimum margin]. At a cost of say £20m it is not material and repurchase if announced might improve policyholder confidence.

[14:10] The Head of Life Insurance forwards this on to the Director of Insurance, saying that he had:

… told [Equitable’s Finance Director] that we would look again at this when the compromise scheme was out. [FSA’s Insolvency Practitioner’s] initial view is that the key issue is whether Equitable is likely to become insolvent before the scheme is completed. If not, the buyback is likely to be in policyholder’s interests. Only if insolvency intervenes might policyholders lose as they would no longer get preference over the bondholders for the portion of the debt bought back. Otherwise, the current price makes this a good deal for policyholders.

The Head of Life Insurance says that the issue would need to be considered by FSA’s Insurance Supervisory Committee and he asks the Director of Insurance whether he was content for the case to be put to the Committee.

FSA’s Head of Life Insurance tells the Head of Press Office that FSA did not know what the Independent Actuary would say at the time of the launch of the compromise scheme and that any statement might therefore have to be dropped.

[11:59] The Head of Press Office says that, if the Head of Life Insurance was saying that the Independent Actuary was not going to say anything then ‘there is a problem’. The Head of Press Office explains that he: ‘thought as part of the compromise, the independent actuary was going to offer a “view” as to the overall fairness of the proposals put forward for consultation. Other than the financial press and rent-a-quote financial advisers, this view was about the only steer policyholders would get at this stage to help them determine how to respond to the consultation (we are saying: “sensible basis on which to consult”, but we won’t offer a formal view till the final proposals are put together for the vote)’. He continues that: ‘If there is no such “view” from the independent actuary at this point … how do policyholders start to gauge fairness in order to feedback? Plus I think there is an expectation that the independent actuary will actually say something tomorrow’.

An official circulates ‘what is hopefully’ the final version of FSA’s press notice.

[15:54] Chief Counsel A says that she remained ‘a bit uncomfortable with the first sentence of the press release which I know does not literally promise a stable fund following a successful compromise, but it does stray towards it’.

[16:44] The Head of Life Insurance says that he believed the reference to ‘stability … is OK in this context, and can be interpreted as referring to the removal of the uncertainty created by the uncapped liabilities’.

FSA’s Chief Counsel B checks with the Head of Life Insurance, Chief Counsel A and the Head of Prudential Policy that they were happy with an extract from Counsel’s opinion about non-GAR policyholders who surrender their policies, and the operation of the market value adjuster.

[15:12] Chief Counsel A and [16:25] the Head of Life Insurance say that they are happy with it.

FSA’s Insolvency Practitioner raises a point with the Head of Life Insurance, being that ‘the Society’s Q&As include the statement that they are publishing all the relevant Counsel’s opinions. Yet [Counsel’s] opinion (which I do not believe they intend to publish) contains some highly relevant views on the strength (or lack of strength) of potential misselling claims’.

[15:39] The Head of Life Insurance understands that Equitable hoped to publish the opinion but that ‘like so much else!’ it was not yet finalised.

FSA’s Head of Life Insurance sends to 13 FSA officials electronic copies of documents delivered that morning from Equitable. Those documents were:

• Equitable’s question and answer paper on the compromise scheme.
• Equitable’s media timetable.
• A document entitled ‘[the Appointed Actuary’s company’s] Papers – Realistic G…’.
• A document entitled ‘[the Appointed Actuary’s company’s] Papers – Assessing P…’.
• The final report from the Appointed Actuary’s company of their independent review of Equitable’s financial position (requested by FSA on 11/09/2001 [14:00]).

On the last document, the Head of Life Insurance explains ‘the substance was given to us several weeks ago, but was marked “draft” – we asked them to give us a final version, even though there has been no additional work since then’.

Equitable send FSA their question and answer briefing for the compromise scheme proposals.

[16:13] The Head of Life Insurance circulates the briefing and notes that the Independent Actuary would not be making any statement on the compromise but that he had told Equitable that he regarded the principles underlying the scheme to be appropriate and applied fairly.

An FSA official seeks comments on an amended version of FSA’s information sheet on Equitable and on the contents of their web page.

[20:57] Chief Counsel A provides comments on the web page.

Equitable’s advisers inform FSA of the procedure for production of the Creditors’ Pack.

[14:39] FSA’s Insolvency Practitioner suggests that FSA should now turn their minds to what they would say at the convening hearing.

The Head of Life Insurance and, the following day, Chief Counsel A comment on the Insolvency Practitioner’s suggestion. Chief Counsel A concludes that FSA would have little of substance to say at the convening hearing, as opposed to the substantive hearing. She makes some proposals as to how FSA should prepare to handle that process.

FSA send the German, Guernsey and Republic of Ireland regulators copies of the compromise scheme launch document and FSA’s press notice of that morning.

[14:06] FSA inform Equitable of this.

FSA’s Head of Life Insurance suggests that the question and answer briefing material for responses to independent financial advisers was ‘getting over complicated’.

The Head of Life Insurance suggests:

… a couple of short sharp responses, focusing on the publication of the compromise proposals on the following lines:

Question: Does the FSA expect [Independent Financial Advisers] to give advice to Equitable Policyholders, even though the [Independent Financial Adviser] does not want to?

[Answer]: This is entirely for each [Independent Financial Adviser] to decide (subject to any obligations they may have to existing clients who are Equitable policyholders). The FSA neither requires nor prohibits [Independent Financial Advisers] from giving advice in particular cases.

Question: How should an [Independent Financial Adviser] determine what advice to give an Equitable policyholder, as to whether or not to accept the compromise scheme?

[Answer]: [Independent Financial Advisers] who advise Equitable policyholders on the Compromise Scheme should apply their professional judgement within the existing PIA rules. The Equitable has published a great deal of information about the Compromise Scheme itself; but it will be important that [Independent Financial Advisers] take fully into account the individual circumstances of the client.

[16:43] FSA’s Press Office say that they are happy with the proposed line to take, while noting that ‘If [Independent Financial Advisers] can’t give advice, who can!’. They also say that it is ‘[worth] remembering, to counter any suggestion that we [are] warning [Independent Financial Advisers] off advising Equitable customers, that we and our website consistently advise people to take advice’.

Equitable send FSA a balance sheet and profit and loss statement for 31 August 2001. The figures are presented as follows:

Equitable send FSA an initial external review of the Creditors’ Pack.

[10:31] The Head of Life Insurance circulates the information.

FSA’s Head of Life Insurance sends the Insolvency Practitioner and the Head of Actuarial Support the financial information received from Equitable on 21/09/2001. The Head of Life Insurance asks whether the information complied with their requirements.

[11:48] The Head of Actuarial Support replies:

My understanding is that they now consider they need to hold around £850 million for mis-selling, and that they are not including any provision for those non-GAR policyholders who have already left.

In addition, we know that markets have fallen substantially since end-August though correspondingly they have increased the financial adjuster on surrenders (and may therefore be able to discount their guaranteed funds rather more).

I think therefore that we should ask the actuary for an urgent update of their financial position taking account of all these factors.

[12:47] The Insolvency Practitioner comments:

There is, as yet, no s.45 requirement. However, what has been supplied does not comply with the draft requirements. The Policy Value information … has, once again, not been completed.

The Society has shown a provision of £220m for non-GAR misselling costs. This is the wrong figure to use as a matter of principle. They should use the gross “realistic estimate” cost of £850m. If they did this, then the Society would exceed its required solvency margin by a mere £50m. Given stock market falls since 30 August, the Society must surely be in breach of its [required minimum margin] now. If so, the statements that it is making about solvency in the course of consultation need to be tempered.

FSA’s Chief Counsel B writes to the Head of Life Insurance about the meeting that morning about Equitable’s Creditors’ Pack. The Chief Counsel says that, had he attended the meeting, he would have agreed with the view that FSA needed to have a reliable means of knowing what policyholders were saying in response to the consultation. Chief Counsel B also says that he understood that the Head of Actuarial Support was undertaking an analysis of which classes of policyholder were likely to be better off with compensation by return of premiums plus interest, rather than by reference to the impact of the GARs. He says that, when that analysis was complete, FSA could consider instructing Counsel.

The Head of Actuarial Support replies:

At the present time, I would estimate that all policies written since around 1997 would be in the position that a refund of premiums plus interest at 5% (Is this the judgment rate?) would be greater than the underlying policy value. This should include all policies written since 1995 if we allow for the policy values being around 8-10% too high at the present time (ie they are not supported by the underlying value of assets).

For regular premium policies, the cutover date would be around 1995 or 1993 respectively.

This indicates that we are talking about around 100,000 individuals, plus perhaps 200,000 members of group schemes, who could be better off with a recission of their contract if this option were available to them (though I am not sure what form of contract exists for members of group schemes). I would expect this to cover all types of policy, including retirement annuities, with-profit immediate annuities, endowments, single premium bonds etc.

If we were to allow for the effect of the application of a financial adjuster on surrender, then even more policies would need to be included.

Equitable send FSA the weekly reports of the amounts of claims advised and processed. The information provided included that, for the week ending 21 September, there had been £50m of claims at maturity and £58.9m of claims for surrenders. The information also showed that the backlog of unprocessed claims had increased from around £100m at the end of July 2001 to around £500m at the end of August 2001, the backlog then remaining at between £400m and £500m.

FSA’s Head of Life Insurance distributes the information the following day (at 10:28).

Equitable send FSA a copy of the side letter to the reinsurance treaty, dated 1 April 1999. They explain: ‘We are seeking clarification of the side letter and we have had legal advice that it is unclear as to what it means. However [IRECO] is extremely preoccupied with the World Trade Centre disaster’.

(Note: the fax is dated 14 September 2001; however, the fax transmission records that it had been sent from Equitable on 24 September 2001 at 18:41.)

FSA’s Head of Life Insurance comments to the Head of Actuarial Support (copied to others) about the side letter, that: ‘I think we will need to consider with GCD what this means. It is not a legally binding document: and it fails to achieve its stated aim of “clarifying” the position. But paragraph 2 appears to cast some doubt on the effectiveness of the treaty in certain circumstances’.

On another version of Equitable’s fax of 24/09/2001, the Head of Actuarial Support writes to the Head of Life Insurance (copied to Chief Counsel A and Scrutinising Actuary F) expressing his concerns that: the side letter had not been disclosed to FSA or GAD; the second paragraph was completely at variance with what they had been told by the then Appointed Actuary at the meeting in February 1999; and the third paragraph could very well invalidate the reinsurance offset shown in the returns.

(Note: the Head of Actuarial Support’s note is undated; however, it was written on a version of Equitable’s fax of 24/09/2001 that had been date-stamped 25 September 2001.)

FSA’s Head of Actuarial Support responds to the Insolvency Practitioner’s note on the financial information received from Equitable (see 21/09/2001 [19:53] and 24/09/2001 [11:17]). The Head of Actuarial Support says that he agreed with his assessment and adds that the policy value information would be likely to show policy values 8-10% higher than underlying assets.

[14:32] The Head of Actuarial Support comments further, having now received a copy of the side letter to the reinsurance treaty, saying:

We have a further problem that has emerged. Apparently, [Equitable’s Appointed Actuary] signed a side-letter on behalf of Equitable which was not disclosed to us, but calls into serious question the validity of the reinsurance offset of £700 million for which they are taking credit. This would of course mean that they are now well below their required margin of solvency.

The Head of Life Insurance adds: ‘This would not have been known either to Baird et al but should be an interesting topic for Penrose to pursue!’.

FSA’s Director of Insurance informs Managing Director B of the disclosure by Equitable of the side letter. He notes that, although the letter had been explicitly expressed as not being legally binding, it ‘would appear to cast doubt on the reinsurance treaty on which the Equitable relied to cover the reserves which we insisted the Equitable set up to cover their GAR liabilities’. The Director refers to his letter to the Society of the previous day. He says that, in addition, he had also spoken to Equitable’s Chief Executive and had stressed that the Society must take immediate steps to put the issue beyond doubt, ‘if need be by negotiating a further amendment to the Treaty or by securing a formal and binding acceptance by Ireco that they would not seek to rely on the side letter’.

The Director goes on: ‘Our immediate concern must be to assess the implications of the letter and to ensure that the Equitable does whatever is necessary to put its financial position (at least in this respect) beyond doubt’. He says that FSA would need to consider whether to investigate the matter, inform the Serious Fraud Office, and review which other life companies had any exposure to IRECO. The Director of Insurance also states that:

Ireco is an Irish reinsurance company (a subsidiary of [Prospective Bidder F]). As such it is not supervised by the Irish Insurance authorities. However if, as may be the case, Ireco has specialised in assisting companies to disguise their true financial position by entering into “bogus” (or at least doubtful) reinsurance treaties then this may fall foul of other requirements of Irish law. Subject to comments from enforcement I should like to discuss this urgently with the Irish supervisory authority (who do maintain a somewhat distant watching brief over the reinsurance sector). It may also be appropriate for there to be contact with Irish company and/or criminal investigation authorities.

[11:57] FSA’s Head of Actuarial Support comments:

There is clearly a serious issue here over the conduct of [the individual] who was the appointed actuary and finance director when he wrote this letter in April 1999. This letter was never disclosed to us. Moreover, its contents are at variance with what we were led to believe in discussions with him in January and February 1999. Thirdly, if the side-letter is legally binding, then I believe it would also seriously call into question the value of the reinsurance offset for which he [has] claimed credit in his valuation of the liabilities in both the 1998 and 1999 financial returns.

These points alone would in my view be sufficient to warrant a formal complaint about his conduct to the actuarial profession.

There are also of course a series of possible issues relating to the financial management of the Equitable, including whether policyholders were misled as to their expectations, on which a complaint to the profession against [the former Appointed Actuary] and others at Equitable Life could be mounted. We had held off on these broader issues while the various other enquiries were continuing.

FSA’s Chief Counsel A prepares instructions for Counsel to advise on the status of the side letter and asks for comments on them from the Head of Insurance Policy.

[17:34 and 17:59] The Head of Insurance Policy provides some comments, including:

You also correctly point out that even if the side-letter is not legally binding it raises serious questions as to the legitimacy of its use to support provisioning. You will recall that [Regulation] 64(3) of the 1994 [Regulations] makes this depend upon actuarial principles. I have remembered that we have given guidance (which in fact I wrote) on how these principles are to be applied. See Guidance 1998/1 (para 5.5.(6) of Guidance Note 9.1 in the [Interim Prudential Sourcebook]). This makes reliance upon such reinsurance dependent upon both the legal form and economic substance. I have not copied this paragraph of guidance out as I assume you have easy access to it.

[17:53] Chief Counsel A sends the instructions to Counsel.

[19:33] Chief Counsel A sends the Director of GCD a copy of the instructions to Counsel. The following day, he suggests a further point to ask Counsel.

FSA’s Director of Insurance asks the Head of Actuarial Support to consider what could be done to enable FSA to monitor and model Equitable’s financial position.

[14:09] The Head of Actuarial Support replies:

I would certainly agree that we need to have the up-to-date financial position from [Equitable’s Appointed Actuary], along with their current thinking on bonus rates and the financial adjuster on the surrenders. I propose to modify the generic [Chief Executive Officer] letter slightly for them, and tailor this to their specific circumstances. In particular, we shall wish to discuss in more detail how they intend to provide for potential mis-selling costs.

They have also in the past provided us with a matrix showing how this would alter in the event of changes in equity values or in fixed interest yields. I would certainly like to request this again, as we do not have the data ourselves to construct reliably such a model.

In response to the instructions sent to Counsel on the side letter (see 26/09/2001 [16:36]), the Head of Actuarial Support says:

I would be doubtful about allowing even a value of £100 million in view of the intent expressed that they would never wish to make any “cash” claim on the reinsurer!

Another aspect, but I think for later, might be the role of [the Appointed Actuary’s company] (were they aware of the August correspondence?) and the auditors … who are required by regulation to report events of “material significance”.

Equitable ask FSA for an idea of their ‘success criteria’ for Equitable’s consideration of policyholders’ comments and feedback on the compromise scheme proposals.

[16:23] FSA’s Head of Life Insurance replies: ‘I think the Society needs to demonstrate that it has taken account of all representations and comments, and that any changes to the scheme (or decisions not to change it as the case may be) are fully explained and supported by reasoned argument’.

HMT reply to FSA’s letters of 06/03/2001, 10/08/2001 and 17/08/2001. HMT agree that it would be desirable to achieve some certainty on the meaning of Article 4 of Equitable’s Articles of Association, without the need for it to be determined by the courts. HMT say: ‘In particular this would help avoid the possibility that the continuity of payments could be disrupted if Equitable Life were to be placed in administration or provisional liquidation. The difficulty we continue to have is that, in our view, both solutions proposed in [the Director of Insurance’s] letter would not solve the problem’.

FSA’s Director of Insurance comments on the letter: ‘I see little point in going back on this’.

FSA have a discussion with Counsel about the side letter and their instructions of 26/09/2001. According to Chief Counsel A’s summary, which recorded Counsel’s preliminary comments (prepared to assist with FSA’s meeting with Equitable later that day and not cleared by Counsel), the legal questions were:

• Must Equitable cancel the reinsurance when the £100m limit is reached?
• If not, can it nevertheless use the reinsurance agreement to offset its provisioning? Or to offset it in the amount of £700m?
• Can Equitable only draw cash if the conditions in the side [letter] are met?
• If so, does this matter only for reserving?

Chief Counsel A records that good legal arguments existed to the effect that the side letter should have no legal effect or could be withdrawn by Equitable. However: ‘in the interim unless Equitable has very confident and credible legal advice, the FSA will need to consider urgently whether, in view of the legal uncertainty, it would be prudent for the Equitable to claim the full £700m (ICR 1994)’.

Chief Counsel A also records the following under ‘Other questions’:

• Did present management of the Equitable (breach of criteria of sound and prudent management?), its audits (breach of [Regulation] 3 of the Auditors (Insurance Companies Act 1982) Regulations 1994?) or its appointed actuary (breach of professional guidance?) know about the side letter in August when [Equitable’s Appointed Actuary] wrote to [FSA’s Head of Actuarial Support] on 7 August? Before publication of the Launch Document?
• Did [Equitable’s then Chief Executive] know about the side letter (almost certainly yes) (breach of professional guidance?).

FSA meet Equitable and their auditors.

According to FSA’s note of the meeting, on the side letter:

[Equitable’s Finance Director] said that on 7 August, after [Equitable’s Appointed Actuary] had sent his letter of that date to [FSA’s Head of Actuarial Support], [the former Appointed Actuary] (who had been consulted on the terms of that letter, and had agreed with them) had reverted to [the Appointed Actuary] with a copy of the side letter saying that he ought to be aware of it. Equitable Life then made further enquiries. They had found no reference to the side letter in the minutes of board meetings. They held discussions with the reinsurers, with their lawyers and with [the former Appointed Actuary].

The reinsurer (IRECO), had described the side letter as providing clarification of what would happen if the £100 million trigger level was reached; but these discussions left Equitable Life unclear on how the side letter related to the treaty. In late August, IRECO told [Equitable’s Finance Director] that the letter represented “best endeavours” to achieve a satisfactory resolution in these circumstances. However, on 27 September IRECO gave Equitable their view that the side letter gave IRECO the option to terminate the Treaty. Equitable Life have told IRECO that they do not accept that interpretation. But they have disclosed the position to their [directors and officers] insurer, and [the Finance Director] is meeting the general counsel of [IRECO] this week.

The advice of [the Society’s solicitors] to date is that the side letter is not necessary to interpret the Treaty; that the Treaty allows for arbitration, and that although a court might not take account of the side letter, an arbitrator might. Arbitration would be under the jurisdiction of the country of the counterparty, namely Irish jurisdiction.

On Equitable’s financial position:

[Equitable’s Appointed Actuary] said that the Equitable continued to meet its required margin of solvency. The assumptions which he made in reaching this view were that the Equitable would be granted a Section 68 order to take credit for the changes to the valuation rate of interest being brought in [when FSMA 2000 comes into force]; that the resilience test would not impose any additional liability; that the provision for non-GAR mis-selling was £220 million; that only £100 million credit could be taken for the Reinsurance Treaty; that the GAR takeup rate was assumed to be 85% rather than 90% as at present; and no provision had been made for those leaving the funds. On this basis, there would be an excess of about £400 million over the [required minimum margin].

A discussion followed on the basis for calculating the liability for mis-selling. The FSA argued that the liability must be higher than £220 million, since this was the figure assumed under the scheme, where a discount was allowed for the fact that non-GAR policyholders would be paying for about 75% of their own compensation. However, a reserve needed to be sufficient to cover the possibility that the scheme did not go through, and in that circumstance the FSA believed that it would not be appropriate to allow a discount for policyholders having to meet most of their own compensation.

In response to this, the argument was put forward that even if the scheme did not go ahead, and policyholders went to the Ombudsman, the Ombudsman would have to consider the effect of any compensation award paid to an individual policyholder, on all other policyholders, and that since there was likely to be a very large number of claims, this would result in compensation awards being adjusted to take account of the total size of the mutual fund: so that the effect would be the same as the discount under the scheme.

The FSA were not entirely convinced by this argument, and Equitable Life agreed to write to the FSA addressing this point in a more considered way.

Equitable’s auditor ‘wished to draw the FSA’s attention to the importance of the topics under discussion, for the purposes of the notification requirements placed on the auditor’.

FSA’s Head of Actuarial Support writes to Chief Counsel A after the meeting, saying:

The [Appointed Actuary’s company’s] letter of engagement understandably includes the usual set of disclaimers and caveats. However, it does place certain requirements on the directors, including

“The Directors will provide to us appropriate confirmation that all the information, explanations and documentation provided to us are true, accurate, complete and not misleading and that we are entitled to rely on them”.

In the slides for the presentation to FSA, [the Appointed Actuary’s company] included the sentence

“Renegotiation or withdrawal of the GAR reinsurance treaty could have a significant impact on solvency. We note that in most circumstances, change is subject to [Equitable’s] agreement, but this is a dependency (a successful Compromise Scheme vote would eliminate the risk)”

Nevertheless, the balance sheet that they included in their presentation allowed for a value of £674 Million to be ascribed to this reinsurance agreement.

No mention was made of the existence of this side-letter by either [the Appointed Actuary’s company] or Equitable at the presentation itself.

[20:00] Chief Counsel A replies that FSA would need to bring this to the attention of ‘the investigator’ in due course.

Behind this note on the regulators’ files is a briefing note by a legal firm on company law reform and a review carried out by the Company Law Review Steering Group. The following paragraph has been highlighted:

The Final Report also recommends an extension to the duties of directors and employees to assist auditors in the execution of their statutory duties. It is already a criminal act for a director or officer of a company knowingly or recklessly to provide misleading, false or deceptive information.