Submission of the 1989 regulatory returns

Companies Act annual report and accounts In the President’s Statement, Equitable again say that they have experienced significant increases in new business and that the total value of assets under management increased by £1.5bn to £5.7bn.

Equitable’s President says that recurrent single premium policyholders had been sent with their bonus notice a letter outlining the Society’s change in approach to determining final bonus. The President explains:

The Society has taken a positive lead within the life assurance industry in trying to strip away the cloak of mystery behind which the with-profits bonus system has been hidden. So far we have received high marks for effort but less uniformly high acclaim for simplicity of explanation. We accept that we have a duty to enable the public to know what they are being offered and we are confident that the public will buy good products they understand.

Equitable’s President continues:

Our principles for operating with-profits business are essentially very simple. The policy results we can pay depend on our investment performance and the efficiency of our business operations. The investment returns are averaged over time to provide a greater degree of security than is sought by those investing in either unit-linked policies or unit trusts and to avoid very large differences in policy results over short periods of time. We also aim to give a fair return to each policyholder whether the policy runs the originally planned term or not and to hold back the minimum by way of reserve consistent with prudent management.

In the Management Report 1989, as in the President’s Statement in the 1988 annual report and accounts, Equitable state that they are ‘unusual in that our relatively low cost of sales has enabled us to expand fast without financial burden to our existing members’. Under ‘New Business’, the report says that new regular premium business for the year was £234m and new single premium business was £408m, the latter being an increase of 212% on the previous year. Equitable provide a table illustrating the growth in new premium income over recent years and explain that:

… by far the major contributor to new business was the Society’s personal pension plan which benefited immensely from the public’s increased awareness of pensions. In addition the Society received a significant amount of new premium income in the form of increments on old style retirement annuity contracts which are no longer available to new policyholders, vindicating, as the President has reported, the Society’s strategy of telling policyholders of the advantages to be gained from such contracts.

The report also sets out developments on ‘Investments’, ‘Services and Systems’ and ‘Staff’.

The Statement of Bonuses section of the report runs to two pages and covers the levels of bonus declared and the changes that have been made to the system of allocating final bonus. For their main line of business, Equitable again maintain declared reversionary bonus at 7.5%.

On final bonus, Equitable write:

The addition of final bonus is intended to increase the guaranteed policy benefits and attaching declared bonuses to the appropriate total level having regard to the Society’s experience over the period for which the policy in question has been in force. An important feature of our approach is that the Directors aim to achieve the highest possible benefits. In particular, we do not consciously retain earnings to build up the “strength” of the office or to maintain unnecessary reserves …

Under recurrent single premium contracts the policy is essentially building up a fund of money, although the contractual benefits may be expressed as payable at some future date (e.g. at age 60). Part of that fund at any time will consist of the value of the guaranteed benefits (those secured by the premiums paid and declared bonus additions). The remaining, un guaranteed, part represents the final bonus that would be paid if the policy benefits became payable immediately.

Equitable then go on to explain the new system, saying:

Previously the Society has determined the final bonus element under a recurrent single premium contract at any time by reference to a specific scale of rates. That has now been changed to bring the system more into line with the “accumulating fund” nature of the contract. Each year the Society will announce a rate of growth at which the total policy benefits were built up over the year of the declaration, together with a second rate to apply for the period beyond the date of the declaration.

The guaranteed part of the total benefits continues to grow, as before, through the operation of the basic contract terms and declared bonus additions. The final bonus element of the policy value at any time is the difference between the total value and the value of the guaranteed part.

Equitable provide illustrations of how the new system works for a personal pension contract and a bond. The illustration for the personal pension states that the contract includes a guaranteed ‘rollup rate’ of 3.5%.

Equitable state that policy proceeds for policies maturing after 1 April 1990 will be greater than was the case for comparable policies maturing the previous year.

The returns Equitable’s returns are again submitted in two parts covering Schedules 1, 3 and 6 and Schedule 4 to the ICAS Regulations 1983.

Schedule 1 (Balance sheet and profit and loss account) As in previous years, Schedule 1 of Equitable’s returns consists of Forms 9, 10, 13, 14 and 16. Form 9 summarises the Society’s financial position at 31 December 1989 as follows:

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

As in previous years, Schedule 3 consists of Forms 40 to 51, which have been supplemented by various notes providing further information about/explanation for the figures provided.

Form 45 shows that 55% of Equitable’s non-linked assets are invested in equities, 12% in land and 26% in fixed and variable interest securities (compared with 45%, 14% and 35%, respectively, in 1988).

As in their 1988 returns, Equitable disclose in Form 46 that the gross redemption yields on fixed interest securities issued or guaranteed by any government or public authority and with durations of less than 15 years are consistently higher than for those not issued or guaranteed by any government or public authority.

The notes to this part of the returns include a statement that no provision has been made for the contingent liability for corporation tax on unrealised capital gains for non-linked business, which is estimated not to exceed £28m.

Equitable also state again that they have been granted a section 68 Order which permits them to include in aggregate form details of their ‘Personalised Funds’ in Forms 49, 50, 51 and 57, instead of the separate details for each Personalised Fund required by the ICAS Regulations 1983.

Schedule 6 (Certificates by directors, actuary and auditors) Three Equitable Directors provide the certification required by Regulation 26(a) of the ICAS Regulations 1983. Equitable’s Appointed Actuary provides the certification required by Regulation 26(b) of the ICAS Regulations 1983. As required by Regulation 27 of the ICAS Regulations 1983, Equitable’s Auditors provide their opinion that Schedules 1, 3 and 6 of the returns have been properly prepared.

Schedule 4 (Abstract of valuation report prepared by the Appointed Actuary) As in previous years, Equitable present two valuations of their long term liabilities (their main and appendix valuations). The results of the main valuation are carried forward, unadjusted, from Form 58 to Form 14 and on to Form 9.

Schedule 4 – main valuation (text) Schedule 4 of Equitable’s returns answers the questions set out in paragraphs 1 to 19 of Schedule 4 to the ICAS Regulations 1983 and includes Forms 55 to 58 and Form 60. Equitable state that this valuation conforms to Regulation 54 of ICR 1981.

In response to paragraph 3 of Schedule 4, Equitable provide ten pages of information about their non-linked contracts. Most of the information about the contracts remains unchanged from the previous returns.

The description of Equitable’s with-profits immediate annuity business (paragraph 3(xi)) is changed from the previous year’s returns and no longer mentions that guaranteed benefits increase by 3.5% each year. The relevant part reads:

The basic contract provides level guaranteed benefits, which are enhanced by the addition of bonuses, including final bonus.

Under alternative versions of the contract the guaranteed payments may be arranged to increase at 3½% per annum or to decrease at a rate of up to 6½% per annum (in ½% steps).

The descriptions of Equitable’s retirement annuity, personal pension plan and individual pension plan contracts (paragraphs 3(xiii), 3(xiv) and 3(xv)) are the same as the previous year’s returns.

The description of Equitable’s principal guarantees of terms at the end of paragraph 3 is the same as the previous year’s returns. As in their 1988 returns, Equitable disclose that certain deferred annuity policies carry guaranteed terms under which future premiums could be paid. Equitable also, again, disclose that they applied a guaranteed annuity rate to the accumulated cash fund generated by these policies.

In response to paragraph 4, Equitable provide 31 pages of information about their linked contracts. Most of the information about the contracts remains unchanged from the previous returns.

As in their 1988 returns, in paragraph 5 Equitable disclose that they have tested the ability of the Society to hold reserves which satisfy Regulations 54 and 56 to 64 of ICR 1981 in the changed investment conditions described in DAA1. Equitable state:

In these conditions the Society would be able to set up reserves which satisfy [Regulations 54 and 56 to 64 of ICR 1981] without needing to have recourse to the assets whose current value is shown at line 51 of Form 14 [in Schedule 1] of these Returns. No provision was made for any mismatching between the nature (including currency) and term of the assets held and the liabilities valued.

(Note: the entry at line 51 of Form 14 was the excess of the value of admissible assets representing the long term fund over the amount of those funds and represented the difference between the market value and book value of those funds.)

Equitable again state that, in determining the provision needed for resilience reserves and tax on unrealised gains, they have taken account of the fact that the long term fund has been valued at book value.

In paragraph 5(1)(e), Equitable disclose that a reserve for the prospective liability to tax on unrealised capital gains is held in respect of policies where benefits are linked to the Society’s internal funds. Equitable also repeat here that the contingent liability for tax on unrealised capital gains in respect of other business is estimated not to exceed £28m. They consider there are sufficient margins in the valuation basis to cover this amount and, accordingly, they again hold no specific reserve.

As in their 1988 returns, in paragraph 5(1)(f) Equitable state that, in current conditions, they do not consider it necessary to hold a specific reserve for the guarantee they offer on a unit-linked annuity.

As in their 1988 returns, in paragraph 6(1) Equitable disclose that for certain nonprofit deferred annuities, the valuation rates of interest used were those assumed in the premium basis. Equitable, again, do not elsewhere disclose the rates used in the premium basis.

As in their 1988 returns, in paragraph 7(b) Equitable disclose that they maintain a general expense reserve of £10.5m, which relates mainly to any shortfall of future premium loadings on regular premium business. Equitable again disclose that they make no other explicit provision for future expenses on their recurrent single premium business or for business where premiums had ceased or were no longer payable. Equitable again do not explain the method by which they have made provision in the main valuation for expenses on recurrent single premium business.

As in the previous returns, at paragraph 7(d) Equitable say:

A further valuation has been undertaken using the net premium valuation method. The bases employed are in accordance with Regulations 55 to 64 of the Insurance Companies Regulations 1981. The resultant aggregate liability is less than the aggregate liability on the methods and bases described in this report. The report on the net premium valuation is given in an appendix following Form 60 of this report.

As in their 1988 returns, in paragraph 11 Equitable state that they have ‘no business where the rights of policyholders to participate in profits relates to profits from particular parts of the long term business fund’.

As in their 1988 returns, in paragraph 12 Equitable simply state that ‘the principles upon which the distribution of profits among policyholders is made are determined by the Directors in accordance with the Society’s Articles of Association’.

In paragraph 13 of Schedule 4, Equitable set out the levels of declared bonus and disclose that they again had set the reversionary bonus for the main policy classes at 7.5%.

As in their 1988 returns, in paragraph 13(b) Equitable disclose that some retirement annuity and individual pension policyholders have been offered loans under a ‘loan back’ arrangement.

In response to paragraph 16, Equitable describe their new system for determining final bonus. For the Society’s main policy classes (being: ‘retirement annuities, personal pension retirement benefits, individual and group pension arrangements, annuities in payment and recurrent single premium deferred annuities’), Equitable state the following:

… the final bonus entitlement as at 31 December 1989 is that amount required to increase the proportion remaining in force on the date of benefit payment of the annuity entitled to participate in course of payment or of annuity or other benefit ranking for bonus from 31 December 1989 or earlier and existing bonus additions (included new declared bonus) valued at that date in accordance with the contract terms to a total policy value on that date calculated as the sum of:

(a) The proportion remaining in force on the date of benefit payment of the annuity entitled to participate in course of payment or of annuity or other benefit ranking for bonus from 31 December 1988 or earlier and declared bonus additions valued as at that date in accordance with the contract terms, together with final bonus additions calculated on the scale introduced on 1 April 1989, increased by 20% for the calendar year 1989;

(b) The sum of the proportion remaining in force on the date of benefit payment of all the purchases of annuity entitled to participate in course of payment or of annuity or other benefit applied for bonus in the calendar year 1989, valued at the date of application, each increased by 20% p.a. for the proportion of the year from the date of application of the individual purchase to 31 December 1989.

Schedule 4 – main valuation (forms) In Form 55, Equitable set out the mathematical reserves held for the various types of non-linked contracts along with information on the number of contracts in force, the benefits guaranteed and the rates of interest and mortality assumptions used in valuing them.

In Form 56, Equitable set out the mathematical reserves held for the various types of linked contracts along with information on the number of contracts in force, the value of current benefits, the level of benefits guaranteed on death or maturity and the rates of interest and mortality assumptions used in valuing them. They again disclose that they hold reserves for noninvestment options and other guarantees for many of their unit-linked policies.

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

Schedule 4 – appendix valuation (text) As in the 1988 returns, Equitable explain that the appendix valuation:

… was undertaken solely for the purposes of demonstrating that in aggregate the mathematical reserves determined by the valuation undertaken using the gross premium method, the results of which are reported on the preceding pages, are not less than an amount calculated in accordance with Regulations 55 to 64 of the Insurance Companies Regulations 1981.

Equitable’s appendix valuation provides the information required by paragraphs 1, 5, 6, 7, 9, 17 and 18 of Schedule 4 to the ICAS Regulations 1983. Equitable say that the information required for the other paragraphs (apart from paragraph 19 – being a statement of the required minimum margin in the form set out in Form 60 of Schedule 4 – which, having had ‘regard to the purpose of the valuation’, has not been provided) is identical to that given in the main valuation.

In response to paragraph 5(1)(a), Equitable make the same statement as in the main valuation, that: ‘In these conditions the Society would be able to set up reserves which satisfy [Regulations 54 and 56 to 64 of ICR 1981] without needing to have recourse to the assets whose current value is shown at line 51 of Form 14 [in Schedule 1] of these Returns. No provision was made for any mismatching between the nature (including currency) and term of the assets held and the liabilities valued’.

As in the main valuation Equitable state, in paragraph 5(1)(e), that a reserve for the prospective liability to tax on unrealised capital gains is held in respect of policies where benefits are linked to the Society’s internal funds. Equitable disclose that the contingent liability for tax on unrealised capital gains in respect of other business is estimated not to exceed £28m. Equitable say that they consider there to be sufficient margins in the valuation basis to cover this amount and, accordingly, they again hold no specific reserve.

As in the main valuation, in paragraph 5(1)(f) Equitable state that, in current conditions, they do not consider it necessary to hold a specific reserve for the guarantee they offered on unit-linked annuities.

As in their 1988 returns, in paragraph 5(1)(g) Equitable disclose the ages that retirement benefits could be taken on their personal pension and retirement annuity business.

As in their main valuation, in paragraph 7(b) Equitable disclose that they maintain a general expense reserve of £10.5m but this relates mainly to regular premium business. They again disclose that they make no other explicit provision for future expenses on their recurrent single premium business or for business where premiums had ceased or were no longer payable. Equitable do not explain the method by which they have made provision in the appendix valuation for expenses on recurrent single premium business.

Schedule 4 – appendix valuation (forms) In the appendix version of Form 55, Equitable set out the mathematical reserves held for the various types of non-linked contracts on the appendix valuation basis.

In the appendix version of Form 56, Equitable set out the mathematical reserves held for the various types of linked contracts on the appendix valuation basis.

GAD note that Equitable’s 1989 returns show a rise in premiums receivable, compared with their 1988 returns, of £418m. GAD’s new Chief Actuary for Equitable (Chief Actuary B – who had been the previous Scrutinising Actuary) queries this with Scrutinising Actuary B, asking ‘Can you reconcile Equitable’s increase of £418,000k in premiums receivable!’.

In response to Chief Actuary B’s question, the Scrutinising Actuary says: ‘We will query this [at] the detailed scrutiny stage’ (see 04/12/1990).

Every insurance company is sent by the Government Actuary a letter announcing the introduction of a rolling programme of visits by DTI and GAD officials to life insurance companies.

GAD meet Equitable’s Appointed Actuary and another actuary (who later becomes the Society’s Appointed Actuary). According to GAD’s note of the meeting, prepared on 22 November 1990, the purpose of the meeting was:

… simply to obtain information about the financial position at the year end ie amount of available assets, [required minimum margin], cost of 1990 bonus, amount of new business written in 1990. I had asked for the meeting as a result of comments made by [Equitable’s Appointed Actuary] to [a Directing Actuary at GAD (Directing Actuary A)] and by other people.

Equitable state at the meeting that, at a recent date (GAD note that this possibly refers to the end of October 1990), their total assets exceeded liabilities and mathematical reserves by £55m. GAD note that ‘[the] 1989 returns showed a margin between the published bonus reserve basis and a net premium valuation basis of £340[m]. This would be higher at 31 December 1990 (say £375m)’. Equitable say that they consider that some £325m new business strain could be released in a net premium valuation. They also consider that higher valuation rates of interest could be used in this valuation, thus releasing more free assets. Making these adjustments would increase the excess of liabilities over assets, before declaring any bonus, from £55m to £755m.

Equitable explain that they are considering not paying any reversionary bonus for 1990 (but would pay an interim bonus to policies maturing in 1991). They ask if GAD would be revising the resilience test in the light of the fall in market values of assets since the beginning of 1990. Equitable raise the possibility of applying for a section 68 Order.

GAD’s note of the meeting continues:

When he informed me of the current position, ie that free assets were £55m assuming the same valuation basis as last year, [the Appointed Actuary] asked me whether I had any qualms about the position of Equitable. I had to say that I did. He asked why? I replied that I had not looked at the figures in detail although I knew it was possible to weaken the valuation basis. However, the society had to comply with the valuation regulations and my main concern was whether it would be able to do this if the market fell any further (or even remained at its present level). What about next year, for example? [The Appointed Actuary] said he took my point and he thought that if the market fell by a further 20% they would have problems and he would have to consider what action should be taken. He implied that at such a point he would have to consider reducing the level of new business taken on.

GAD’s note concludes with two comments:

1 [Equitable’s Appointed Actuary] states that the Society is solvent. However, as he is considering not paying a reversionary bonus this year (while at the same time paying terminal bonuses) he must be feeling very uneasy about the current position of the Society.

2 We are carrying out a detailed scrutiny of the 1989 returns in order to get a better feel for the position of the society, and in particular for what margins there are in its current valuation basis and in the alternative net premium basis.

GAD send DTI the note of the meeting held on 14/11/1990. GAD add, in a covering note marked ‘Confidential’:

From what [the Appointed Actuary] says it appears that if he valued the assets on a weaker basis, which still complied with the regulations, there would currently be adequate free assets to cover the [required minimum margin], without a S68 order for implicit items being taken into account. Even if the Society declared reversionary bonuses for 1989 at the same rate as those for the previous year there would appear, on a weaker valuation basis, to be sufficient free assets remaining to cover the [required minimum margin]. Whether the Society is strong enough to declare a reversionary bonus for 1989 and still have sufficient available assets to provide for future contingencies is a matter for the Society’s Actuary and its Board. [Note: the references to ‘1989’ should have read ‘1990’.]

We are carrying out a detailed scrutiny of the 1989 returns, and will advise you if any further points arise.

Following receipt of this, a DTI official notes:

If the Equitable is not going to declare a bonus we need to warn the Minister before it becomes public. Will there be publicity? What about Equitable’s advertising? Does it need to be changed?

GAD write to Equitable’s Appointed Actuary with some queries arising from the 1989 returns, including why the number of ‘Other Creditors’ and pension surrenders has increased considerably, whether there are any surrender/transfer guarantees relating to pension business fund contracts and ‘… what investment return is required to support (i) the current reversionary bonus rates and (ii) the current reversionary and terminal bonuses’.

GAD provide DTI with a one page note explaining that they have completed their scrutiny of the 1989 returns. (A copy of this scrutiny report is reproduced in full within Part 4 of this report.) GAD say that 1989 was exceptional for Equitable because, during the year, new business growth had set a record. GAD continue:

The Society declared unchanged bonus rates and 94% of the total cost of the bonus was financed by a transfer from the investment reserves. If the property values remain depressed and the equity market does not show any bullish tendencies in the [1990s] and beyond, we think that the Society may have problems in maintaining the current bonus rates on its with-profit life and pensions contracts.

The 1989 valuation basis was satisfactory. There was a significant margin in the published mathematical reserves.

Against the last sentence an official has written an unclear comment which reads ‘not [unclear] [unclear] now’.

GAD enclose a copy of their letter to Equitable of 04/12/1990 but add: ‘… we do not anticipate that the replies will affect our view of the solvency position’. Behind this note are two pages of manuscript calculations. On the first of these is written ‘156 – loss on 1990 investments!’.

Equitable’s Appointed Actuary replies to the various queries raised in GAD’s letter of 04/12/1990. He says that the increase in the amount of pension surrenders arises for two main reasons. First, because of ‘a general increase in the level of retirements under our pension contracts. The cash commutations paid at retirement are included in the … figure’. Secondly, because of:

A relatively high level of internal transfers from one type of pension arrangement to another – in particular, transfers from individual FA70 schemes [i.e. defined contribution occupational pension schemes pursuant to the terms of the Finance Act 1970] to personal pensions, which is being encouraged for the smaller cases because personal pensions are simpler to operate than FA70 schemes.

Equitable explain that:

Our pensions contracts generally carry guarantees of the amount that will be paid in the event of actual retirement (whether on the originally stated pension date or otherwise) or death. There are, however, no guarantees on withdrawal in other circumstances, e.g. transfer to another pension provider. It is our aim to pay full value in those circumstances also but there are no guarantees in the matter.

In response to the question about the required investment return, Equitable say:

(i) The rates of declared bonuses announced at 31 December 1989 require earnings of 11¼% p.a. for our pensions business and around 8% net for our life business.

(ii) As you know, for the bulk of our business we do not have final bonus scales in conventional form. Rather, we announce a “total growth rate” in policy values which gives the total accumulated policy value at the declaration date. The final bonus element in that value is the difference between the total value and the value of the guaranteed policy benefits at that date. The question of what rate of growth is needed to support “current reversionary and final bonuses” is not, therefore, meaningful in our case. The “total growth rates” for 1989 were 20% gross and 16½% net. There is no implication, however, that these rates will be repeated in future years. Indeed for actual payments out under pensions business we have been rolling forward 31.12.89 values at 15% pa for most of this year but have recently cut that to 12% pa. You will also have seen from our With Profits Brochure that we emphasise that future bonuses must depend primarily upon future investment returns.

GAD thank Equitable for their letter of 17/12/1990 and say: ‘The information you have provided is most helpful and we have no further queries on your 1989 returns’.

GAD send DTI’s Head of Life Insurance Division (Head of Life Insurance) two notes. The first is from Chief Actuary B, following the meeting with Equitable on 14/11/1990. The note begins by saying that:

There is one point which we think you may need to consider following our meeting with Equitable. If, as seems possible, the society decides not to declare reversionary bonuses this year you would need to consider whether or not there is a risk that the society may be unable to fulfil the reasonable expectations of present and future policyholders.

It continues:

In the event of the society not paying the reversionary bonuses this year, we understand that the intention is to pay interim reversionary bonuses at the 1989 rates in respect of 1990 on all policies maturing in 1991, thus making up for the effect of not declaring reversionary bonuses in 1990. The society intends to maintain payment of terminal bonuses at the appropriate level on policies maturing. This means that for policies maturing in 1991 there would be no adverse effect apart from any changes in the rates of terminal bonuses that might occur. We do not have any information at this stage about the society’s likely intentions in respect of policies maturing later than 1991. In our view what happens at the end of 1991 and later will be largely determined by what happens to the stock market during 1991 and later.

The note then says:

So far as policies maturing in 1991 are concerned, in our view the course of action which the society has suggested it may take does not affect their reasonable expectations – there is likely to be no big change in total bonus payments at maturity. The total bonus payments added to policies maturing in 1992 or later are likely to be more affected by stock market changes occurring in 1991 and later years than by whether or not the society pays a reversionary bonus at the end of 1990. The society may be able to declare a double reversionary bonus at the end of 1991 if the fund can afford it through good investment performance, or again, a special maturity bonus for 1990 may be awarded for claims in 1992, and so on. In effect, total maturity proceeds would be maintained though (on the latter scenario) less would come from reversionary bonuses, with the company having missed awarding one such bonus in 1990.

Chief Actuary B concludes:

Hence, on balance, we do not think that the society’s possible course of action, in itself, leads to a risk that the society may be unable to fulfil the reasonable expectations of such policyholders. If the society had another bad year (or this year’s performance is worse than anticipated) and the company was unable to establish sufficient mathematical reserves on current guaranteed levels of benefits (including past reversionary bonuses) within the resources of the company, that would be a different matter.

At present we do not have enough information about the society to be more specific and indeed, unless the society makes more signals, we do not suggest that further information should be sought. The society is our longest established life company and is well respected in the market.

The second note is from Directing Actuary A. He begins by stating:

After the meeting held yesterday with the actuarial profession, in which there was general agreement that the resilience test under regulation 55 would continue to be calculated on the basis of a 25% fall in the value of equities in current market conditions and present economic and political circumstances, we discussed the position of Equitable, given that decision. You mentioned that you were concerned about their current advertising. This was in the context that, if the Equitable were unable to pay a reversionary bonus this year, policyholders who had taken out policies on the basis of recent advertisements (which highlighted the returns achieved by the Equitable over the past 10 years), might have justification for wondering whether their reasonable expectations would be, or were being, met. You would like the Equitable to examine their advertising to ensure no such complaint could be justified.

It was agreed, therefore, that the most appropriate way of getting this point over to the Equitable would be for me to telephone [the Chief Executive], informing him both about the decision taken at the meeting yesterday and also to put the point to him about the company’s current advertising.

The note continues:

When I telephoned [Equitable’s Chief Executive] earlier this morning, his secretary told me that he was in a Board meeting which would last most of the day. I wondered then if in fact the Board meeting was deciding on what reversionary bonuses should be paid this year. [The Chief Executive] eventually telephoned me back late in the afternoon, and I explained that I was telephoning him, rather than [the Appointed Actuary] because, although the first point was one on which I would normally speak to [the Appointed Actuary], the second was one on which it would be more appropriate to speak to him.

I explained that, on the first issue, I wanted as a matter of courtesy to tell him the result of yesterday’s discussions, which confirmed the conversation I had with him a week ago at the Actuaries Club Dinner when I told him what I thought would be the outcome of our discussions with the profession. He said that he was very grateful for letting him know.

The note continues:

I then went on to say that, on the second point, some officials in DTI had expressed some concern that, if the Equitable were to forego a reversionary bonus this year, some policyholders might wish to complain that they had been misled by the Equitable’s recent advertising. I said that I was sure that he, [the Chief Executive], would be very mindful of the question of advertising and marketing, with his intimate connections with LAUTRO. I told him that what I was trying to indicate in general terms was that if the company was of the view that it was unlikely to declare a reversionary bonus at the year end, it would be helpful if the company were to examine its advertising and marketing literature to ensure that it felt it was not misleading prospective policyholders in the runup to the announcement.

[The Chief Executive] took these comments in the kindest possible way. He said that he was clearly anxious that the company did not mislead any potential policyholders, that it had been their intention to concentrate on the actual payouts over the last 10 years and it was the company’s continued intention to ensure that policyholders maturity proceeds continued to reflect the full performance of the company over the period of the policy, even if a year’s reversionary bonus were foregone. However, as a result of the Board meeting which he had just left, he thought he could put my worries at rest by telling me what the outcome of the meeting was.

The note goes on to say:

It appears that [Equitable’s Appointed Actuary] had presented a paper to the Board which sets out the constraints on bonus policy which emanate from the valuation of liabilities regulations themselves. The company accepts that the regulations are a matter of fact, and have to be abided by. (He also told me that he had passed on to the Board my comments at last week’s dinner that it would be very difficult for the UK to weaken its valuation regulations at the present time when we are having to defend them to other Member States in the context of the Single Market after 1992.)

He then went on to tell me that the view of the Board was that the crunch position for the company would really probably come next year. The Board had received a report from their investment committee which examined the most likely, and the worst likely, outturn for 1991. As far as the most likely outturn was concerned, the view of the Committee was that the investment performance of the company would be quite strong. While there were some pessimistic underlying economic indicators for next year, the report concluded, and the Board accepted, that the most likely outturn for the year was likely to be optimistic. What the company wishes to avoid is to declare a reversionary bonus this year, and then to be unable to declare a reversionary bonus next year when there is an investment upturn. In his view, although the board has not taken any final decisions yet, he considers that it is “pretty unlikely to be in a position of not being able to declare a bonus this year” given the optimistic assessment of investment returns achievable by the company next year.

[Equitable’s Chief Executive] told me that there was clearly a risk in this strategy, but there is a risk in all bonus declarations taken in similar circumstances. I did not enquire of [the Chief Executive] what the likely financial position of the company would be at the end of this year in terms of Form 9 solvency margin – I know that [the Chief Executive] had to go to another urgent meeting at that time and also I do not consider the telephone to be the best medium for discussing such matters.

The note concludes:

In summary, therefore, it seems most likely that the Equitable will declare a reversionary bonus this year, having taken an optimistic view of investment return likely to be achieved by the company in 1991. On that scenario, they would anticipate that they will be able to continue to pay a reversionary bonus next year. There is clearly some risk in this strategy, and if the Equitable goes ahead with a bonus distribution this year and the market subsequently falls considerably, we will need to hold some urgent talks with the company’s actuary, as we would, of course, with other companies that take similar decisions and who are in a similar financial position to (or an even less strong position than) the Equitable.

Equitable’s Appointed Actuary applies to DTI for a section 68 Order for a future profits implicit item of £250m, for possible use in their 1990 returns. He provides financial calculations in support of this application, suggesting that Equitable could seek an Order up to the value of £562.8m.

These calculations include, for the estimated annual profits, the following:

Average annual profit = 703.5/5 = £140.7m

Notes: (a) £92.2m represents one third of the surplus for the triennium ending 31 December 1985.

(b) £65.0m of the surplus arising in 1987 was an exceptional item arising from a change from a policy year to a calendar year method of bonus allocation for the bulk of the Society’s with profits business.

GAD tick the figures supplied in column (A).

The calculations state that the average period to run for the Society’s inforce contracts is eight years. The Appointed Actuary explains:

The periods to run have been reduced to take account of premature withdrawals based on the Society’s recent experience of such withdrawals. In respect of retirement annuity and personal pension contracts for which a range of retirement ages is available, it has been assumed that retirement benefits are taken at the lowest possible age, or immediately if that age has already been attained.

The calculations suggest that the maximum figure permissible for future profits is 50% of £140.7m multiplied by eight years – that being £562.8m.

DTI ask GAD for their views on Equitable’s application for a section 68 Order.