Submission of the 1990 regulatory returns

Equitable also send DTI a declaration under section 94A of ICA 1982 and pay Insurance Fees of£10,000 in respect of their 1990 returns.

These documents include the following information about Equitable’s business and theirfinancial position as at 31 December 1990.

Companies Act annual report and accounts

In the President’s Statement, Equitable note that the Society continues to grow rapidly withthe President being ‘in no doubt that this is a direct consequence of the confidence existingand new policyholders have in the quality and integrity of the Society’s approach tobusiness’. Equitable say that their recent bonus declaration ‘demonstrated vividly the way thewith-profits system protects policyholders from the full effect of short-term falls in assetvalues’, while noting that: ‘Over a long period bonus additions to policies must reflect actualtrends in investment and operating experience of the Society. Those who choose with-profitsrather than unit-linked policies clearly recognise that smoothing out of peaks is a price worthpaying for the avoidance of a trough’.

In the Management Report, Equitable state that new premium income had increased by 30% to£836m, breaking previous levels, with single premium new business policies increasing by 42% to£578m. On investment performance, Equitable say that investment returns for 1990 had beennegative for the first time since 1974. However, Equitable also say that policyholders areprotected by the with-profits bonus system from the full effect of short-term falls in assetvalues.

In the section on bonuses in the Directors’ Report, Equitable disclosed that, in the light of poorinvestment returns and having regard to prudent actuarial principles, they have valued theirliabilities using a higher valuation rate of interest than in 1989.

Equitable’s Annual Report no longer contains a Statement of Bonuses giving detail on specificrates of bonus for major classes of business. Instead, policyholders are directed to one ofEquitable’s booklets, available from branch offices on request. Policyholders are also directedto the Society’sWith-profits Guide for a description of its approach to with-profits business.

The returns

Equitable’s returns are submitted in three parts, covering: Schedules 1, 3 and 6; Schedule 4; andSchedule 5 (Statement of long term business by the appointed actuary). Schedule 5, requiredto be submitted every five years, sets out in detail the Society’s in-force business.

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. Form9 summarises the Society’s financial position at 31 December 1990 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 byvarious notes providing further information about/explanation for the figures provided.

Form 45 shows that 47% of Equitable’s non-linked assets are invested in equities, 13% in land and27% in fixed and variable interest securities (compared with 55%, 12% and 26%, respectively, in1989).

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

In the notes to this part of the returns, Equitable disclose that they have estimated theircontingent liability for corporation tax on unrealised capital gains for non-linked business tobe nil.

Equitable state that they have been granted a section 68 Order which permits them to includein aggregate form details of their ‘Personalised Funds’ in Forms 49, 50, 51 and 57, instead of theseparate 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 ICASRegulations 1983. Equitable’s Appointed Actuary provides the certification required byRegulation 26(b) of the ICAS Regulations 1983. As required by Regulation 27 of the ICASRegulations 1983, Equitable’s Auditors provide their opinion that Schedules 1, 3 and 6 of thereturns 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 mainand 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 ofSchedule 4 to the ICAS Regulations 1983 and includes Forms 55 to 58 and Form 60. Equitablestate that this valuation conforms to Regulation 54 of ICR 1981.

In response to paragraph 3, Equitable provide ten pages of information about their non-linkedcontracts. Most of the information about the contracts remains unchanged from the previousreturns.

Equitable again disclose, in paragraph 3(xii), that they applied a guaranteed annuity rate to theaccumulated cash fund generated by certain types of with-profits pension policies, stating forthe first time that the guarantees applied to policies issued prior to 1 July 1988.

The description of Equitable’s principal guarantees of terms at the end of paragraph 3 remainsunchanged from the previous year, with the exception of a minor amendment to thedescription of ‘Options to effect further policies without evidence of health’. As in previousyears, Equitable disclose that recurrent single premium and variable premium deferred annuitypolicies carry guaranteed terms under which future premiums could be paid.

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

As in previous years, in paragraph 5 Equitable disclose that they have tested the ability of theSociety to hold reserves which satisfy Regulations 54 and 56 to 64 of ICR 1981 in the changedinvestment conditions described in DAA1. Equitable state:

In these conditions the Society would be able to set up reserves which satisfy [Regulations54 and 56 to 64 of ICR 1981] without needing to have recourse to the assets whose currentvalue is shown at line 51 of Form 14 [in Schedule 1] of these Returns. No provision wasmade for any mismatching between the nature (including currency) and term of theassets held and the liabilities valued.

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

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

In paragraph 5(1)(e), Equitable disclose that a reserve for the prospective liability to tax onunrealised capital gains (losses) is held in respect of policies where benefits are linked to theSociety’s internal funds. Equitable state that the contingent liability for tax on unrealised capitalgains in respect of other business is estimated to be nil, and accordingly no other additionalreserve is made for any prospective liability for tax on unrealised capital gains.

As in previous years, in paragraph 5(1)(f) Equitable state that, in current conditions, they do notconsider it necessary to hold a specific reserve for the guarantee they offer on a unit-linkedannuity.

As in previous years, in paragraph 6(1) Equitable disclose that for certain non-profit deferredannuities, a small class of business, the valuation rates of interest used were those assumed inthe premium basis. Equitable, again, do not elsewhere disclose the rates used in the premiumbasis.

As in previous years, in paragraph 7(b) Equitable do not explain the method by which they havemade provision in the main valuation for expenses on recurrent single premium business. Unlikein previous years, Equitable do not maintain a general expense reserve for any shortfall offuture premium loading on regular premium business.

As in previous years, at paragraph 7(d), Equitable state:

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

As in previous years, in paragraph 11 Equitable state that they have ‘no business where the rightsof policyholders to participate in profits relates to profits from particular parts of the longterm business fund’.

As in previous years, in response to paragraph 12 of Schedule 4 Equitable simply state that theydistribute profits in accordance with the principles determined by their Directors and theirArticles of Association.

Paragraph 13 sets out the level of bonus declared for 1990 and records that Equitable had againset the reversionary bonus for its main policy classes at 7.5%. As in previous years, Equitabledisclose that some retirement annuity and individual pension policyholders have been offeredloans under a ‘loanback’ arrangement.

In response to paragraph 16, Equitable again describe their system for determining finalbonuses. (See 29/06/1990.)

Schedule 4 – main valuation (forms)

In Form 55, Equitable set out the mathematical reserves held for the various types of nonlinkedcontracts along with information on the numbers of contracts in force, the benefitsguaranteed 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 linkedcontracts along with information on the number of contracts in force, the value of currentbenefits, the level of benefits guaranteed on death or maturity and the rates of interest andmortality assumptions used in valuing them. Equitable disclose that they hold reserves for noninvestmentoptions 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 thefund surplus.

Schedule 4 – appendix valuation (text)

Equitable explain that the appendix valuation:

… was undertaken for the purposes of demonstrating that in aggregate the mathematicalreserves determined by the valuation undertaken using the gross premium method, theresults of which are reported on the preceding pages, are not less than an amountcalculated in accordance with Regulations 55 to 64 of the Insurance CompaniesRegulations 1981.

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

In response to paragraph 5(1)(a), Equitable make a similar statement to that made in the mainvaluation and in previous years, that: ‘In these conditions the Society would be able to set upreserves which satisfy [Regulations 54 and 56 to 64 of ICR 1981] without needing to haverecourse to assets whose current value is shown at line 51 of Form 14 [in Schedule 1] of theseReturns. No provision was made for any mismatching between the nature (includingcurrency) and term of the assets held and the liabilities valued’.

As in the main valuation, in paragraph 5(1)(f) Equitable state that, in current conditions, they donot consider it necessary to hold a specific reserve for the guarantee they offer on a unitlinkedannuity.

As in previous years, in paragraph 5(1)(g) Equitable disclose the ages that retirement benefitscould be taken on their recurrent single premium with-profits pension business.

As in the main valuation, in paragraph 7(b) Equitable do not explain the method by which theyhave made provision for expenses on recurrent single premium business. Unlike in previousyears, Equitable do not maintain a general expense reserve for any shortfall of future premiumloadings on regular premium business.

Schedule 4 – appendix valuation (forms)

In the appendix version of Form 55, Equitable set out the mathematical reserves held for thevarious 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 thevarious types of linked contracts on the appendix valuation basis.

Schedule 5 (Statement of long term business by the appointed actuary)

For the 1990 returns, Equitable provide the information required by Schedule 5 to the ICASRegulations 1983. The Schedule requires a statement – ‘in such one of the forms set out inForms 65 to 70 as is appropriate to that category of contract, or, in the case of a category ofcontract to which none of these forms is appropriate, in such form and containing suchparticulars as are sufficient to enable an independent assessment of the liabilities of thecompany’s long term business to be made’ for each product listed in Form 55 and Form 56 ofthe returns. The Schedule runs to 130 pages.

Most of the information provided by Equitable uses Forms 65 to 70 set out in the Regulations.Some of the forms completed include supplementary notes.

For the ‘General Annuity Fund, Deferred annuities with guaranteed cash options – withuniform premiums’, Equitable include the following notes:

The policy is written for cash with a guaranteed annuity option.

The terms of the annuity option are such that they would not be exercised underforeseeable conditions.

Typical rates of guaranteed annuity applicable to this business are:

 

Men at 65 – £9.92%

Women at 65 – £8.56%

For the ‘Pension Business Fund, Individual pension arrangements – variable premiums’,Equitable include the following notes:

Examples of the guaranteed annuity rates applicable to this business are:

Men – at 60 £10.26%, at 65 £11.55%

Women – at 60 £9.34%, at 65 £10.33%

The returns show that this class of business totals more than £771m. For ‘Pension Business Fund,Retirement annuities – variable premiums’, Equitable do not provide any notes on the rates ofannuity guarantee applicable.

GAD complete the A2 Initial Scrutiny check on the Society’s 1990 returns. GAD raise Equitable’s priority rating from 5 to 3 but identify no items that are worrying and no items to notify to DTI, to be taken up immediately with Equitable. As part of the check, GAD note:

1.  Deteriorating cover for the [required minimum margin]
2. Loss of working capital for future expansion.

Accompanying the Initial Scrutiny check are two forms (Form B and Form C1) tabulating key figures disclosed in the 1986 to 1990 returns.

An actuary at GAD (who later becomes the Directing Actuary with responsibility for Equitable) attaches a note to the letter of 27/08/1991 addressed to Scrutinising Actuary B and Chief Actuary B:

I do not see how this contract can be valued by a net [premium valuation] method as there are no overall guaranteed benefits on maturity (only accrued benefits from past premiums). A rate of interest of 5½% would in any case be extremely weak, leaving much reduced scope for future bonuses.

The same GAD actuary as in the entry for 29/08/1991 above writes to DTI about the introduction by a named other life insurance company of a guarantee on their with-profits bond that no market value adjustment would be applied if the policy were surrendered after ten years. The GAD actuary says:

Generally we are aware that a number of companies are now issuing this type of contract. These include for example Equitable Life and others which apparently held reserves below the face value of the units at the end of last year.

This practice can only be justified if they currently apply market value adjustments on surrenders, and can reasonably hope to earn a positive rate of return (in addition to future bonus declarations that may be “reasonably expected”) over the period to death or “maturity” of the policy.

Furthermore, we have to be satisfied that they can still set up adequate reserves under changing investment conditions, including a 25% fall in the value of equities and a 3% variation in yields on fixed interest securities.

Equitable’s Appointed Actuary applies to DTI for a section 68 Order for a future profits implicit item of £300m, for possible use in their 1991 returns. The Appointed Actuary provides financial calculations in support of the application, suggesting that the Society could seek an Order up to the value of £405.2m.

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

Average annual profit = 506.4/5 = £101.3m

Notes:

1. £65.0m of the surplus arising in 1987 was an exceptional item arising froma change from a policy year to a calendar year method of bonusallocation for the bulk of the Society’s with profits business.
2. Surplus was increased by £557.0m as a result of changes in valuationbases during 1990.

GAD circle the figure of £557m included in column (B).

The calculations state that the average period to run for the Society’s in-force contracts is eightyears. The Appointed Actuary explains:

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

The calculations suggest that the maximum figure permissible for future profits is 50% of£101.3m multiplied by eight years – that being £405.2m.

GAD’s Chief Actuary B writes to Equitable’s Appointed Actuary with a series of questions on the Society’s 1990 returns. The Chief Actuary asks:

1. for details of figures shown in the returns for debts due from other companies;
2. why Equitable, for the first time, have split the long term business returns for premiums and expenses, revenue and claims into various sub funds, and whether GAD are correct in assuming that the change will not reflect the previous methods of distributing surplus to with-profits policyholders. GAD’s Chief Actuary B notes: ‘… that you have not completed separate Forms 58 for these sub-funds.Would you please confirm that this is correct bearing in mind the requirements of Section 18 (2) (b) of I.C.A. 1982?’;
3. why there has been an increase in Equitable’s ‘other management expenses’;
4. why Equitable have not included any contingency reserves in the 1990 valuation (when £10.5m had been included in 1989);
5. for the product details of Equitable’s with-profits bond and if there were any guarantees within the first five years of this contract;
6. ‘In paragraph 5(a) of the Appendix to Schedule 4 of your report you refer to the resilience test which you have carried out in connection with the valuation using the net premium method. I note your comments and that you would not need to have recourse to assets shown at line 51 of Form 14 of the Returns. There is however a substantial difference in the mathematical reserves shown at line 11 of Form 14, and the amount of the reserves arrived at using the net premium method of valuation. I would therefore like to know the amount of the mismatching reserve which you would have needed to set up had you used the net premium method in arriving at the amount shown in line 11 of Form 14’;
7. what the cost was of the change in the published valuation basis as at 31/12/1990, when compared with the basis used for publication at the previous valuation; and
8. ‘I am wondering what the figures for the Society will look like in the December 1991 Returns. Can you advise us what the position is likely to be at the year end, including the likely amount of the available assets shown at line 25 of Form 9?’

GAD complete their detailed scrutiny of the Society’s 1990 regulatory returns. GAD send DTI a two page note setting out their findings. (A copy of this scrutiny report is reproduced in full within Part 4 of this report.) GAD explain that Equitable have continued to expand rapidly, with new premium income rising by 30%, new regular premiums by 10% and single premiums by 42%, the latter due to the success of the with-profits bond.

GAD explain that, in common with other companies, Equitable have experienced falls in the market values of equities and other assets. As a result:

… the actuary has decided to weaken the valuation basis of the with-profits business. The rates of interest he has used are within the limits laid down in the regulations and could be supported by the yields shown [in the returns] although the margin is small.We are asking a few questions about the valuation basis and we will comment in detail after the replies from the Society.

GAD also explain that:

The cover for the required minimum margin is reduced from 477% (1989) to 177% [for] this year. The main reason for this is the fall in value of the assets (referred to … above). Part of the fall has been covered by a release of £214m from the mathematical reserves arising from the weakening in the valuation basis. Other reasons for the reduction in cover for the [required minimum margin] are (a) growth of new business and (b) maintenance of unchanged bonus rates on with profit policies.

GAD conclude that Equitable are a major player in the recurrent single premium personal pensions market. They attach a copy of their letter to Equitable of 19/11/1991.

Equitable’s Appointed Actuary writes to GAD in reply to the queries in their letter of 19/11/1991. In relation to the questions, as numbered in the earlier entry, the Appointed Actuary:

1. provides the details requested;
2. explains that the Society has split the long term business returns for premiums and expenses, revenue and claims into various sub funds to ensure that changes in reserves during 1990 resulting from changes in valuation bases did not affect Equitable’s liability to corporation tax. He adds that all with-profits policyholders continue to participate in the surplus of Equitable’s long term business fund, and the Appointed Actuary says that he is ‘able to confirm that it was correct to complete only one Form 58 for 1990 in compliance with Section 18(2)(b) of I.C.A. 1982’;
3. explains that ‘other management expenses’ have risen in absolute terms, but, in relative terms, the rise from 1989 to 1990 was only from 34% to 38% of total expenses. The Appointed Actuary says that he is ‘satisfied that, taking account of the level of expenses in 1990, the Society’s reserves continue to make sufficient provision for future expenses’;
4. explains that, from 1976 to 1989, the Society held a general reserve which was primarily for the estimated shortfall of future premium loadings to meet future expenses on contractual regular premium contracts effected before 1976. But:
   Since 1976 the composition of the Society’s business has changed substantially from being mainly contractual premium business to the current position in which recurrent single premium contracts comprise the major part of the business. At the 1990 yearend I came to the conclusion that there was sufficient provision in total reserves for future expenses without the need for a separately identifiable reserve in respect of contractual premium contracts which had become an unnecessary complication;
5. encloses a copy of the Society’s booklet for the product particulars of the with-profits bond and says: ‘There are guarantees within the first 5 years of the contract, details of which can be found in the enclosed booklet … and [in the 1990 returns]’;
6. states: ‘If the Society had shown mathematical reserves in line 11 of Form 14 of the amount calculated using the net premium method of valuation, I would have needed to set up an additional mismatching reserve of £450m’;
7. explains that, if their published reserves had been calculated as at 31/12/1990 using the basis used for publication at the previous valuation, the Society’s reserves would have been £557m higher;
8. explains that the Society would:
   … need to publish a substantially stronger valuation at the end of 1991, either by explicit strengthening of the basis or the inclusion of an explicit mismatching reserve, than at 31 December 1990 reflecting the reduction in yields during the year.

My current view is that it is unlikely that the [solvency] position at the end of 1991 will be any stronger than at 31 December 1990, although the underlying liability valuation will, of course, be substantially stronger.

Equitable’s Appointed Actuary undertakes to provide more detailed information about the year end position when this becomes available (see 12/05/1992). GAD subsequently forward a copy of this letter to DTI (see 23/12/1991).

GAD provide DTI with their views on Equitable’s application for a section 68 Order (08/11/1991). GAD state that the amount requested:

… is less than the maximum allowed in accordance with the calculations based on the guidance notes.

We have no comments on the calculations and we recommend you to issue the S68 order for the implicit item of £300m as requested by The Society.