Appendix C: Summary of events jul 00 - oct 01
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Summary of events: C1597/01
July 2000 - October 2001
2001
04/07/00
SA's managing director told the chairman, and the prudential division's senior managers, that the then senior independent director on the Equitable Board had contacted him saying that while Equitable had no firm idea of the likely judgment, there were "straws in the wind" that the Lords would find against Equitable. The Equitable Board were therefore giving some thought to what ought to be done in the event of an adverse decision. The main concern for Equitable appeared to be "what level of sacrifice" might be needed at the top of the organisation. Their chairman and the chief executive both wished to resign in that circumstance. The Equitable director was worried that that might be unnecessary unless the judgment criticised the way Equitable had operated, and felt that it was vital for their executive to remain at full strength to handle whatever transition was necessary. FSA's managing director had made a note saying that in his view FSA should place considerable emphasis on retaining an adequate executive relationship, and that the presence or absence of detailed criticism in the judgment would be crucial to how senior figures might wish to respond.
05/07/00
Having consulted FSA's chairman and the insurance director, the managing director telephoned the Equitable director. He said that the FSA were anxious to ensure continuity among executives and that any resignations might be phased to permit continuity. It would depend on the material in the judgment but on what FSA knew so far "it was unlikely that they would be throwing brickbats at Equitable".
An undated note in the papers told FSA's insurance director that the head of the prudential division had seen the managing director's note and agreed with what he had said.
07/07/00
GAD recommended that the prudential division support the section 68 order Equitable had applied for on 27/06/00. GAD noted that, although the information provided in the application was a little sparse in places, based on that information there was a significant margin between the amount that Equitable had applied for and the maximum that they could have applied for - which was £3.3bn. GAD said that the appointed actuary had confirmed that he had taken account of the effect of the reinsurance treaty in determining the value of future profits.
12/07/00
FSA's Executive Committee met and were told that the House of Lords' judgment was expected soon.
18/07/00
Equitable met with FSA's prudential and legal divisions and GAD to discuss contingency planning for the House of Lords' judgment, which was due to be given on 20/07/00. The official record of the meeting by the prudential division said that while it was thought unlikely that the House of Lords would find against Equitable, they discussed the possibility that Equitable might be prevented from altering the rate of bonus for policies containing GAR options, so that they would have to give an annuity at the guaranteed rate on unadjusted asset share. A contemporary manuscript note by a GAD officer attending the meeting recorded the opposite conclusion, i.e. that the actual outcome was the "Most likely outcome". [FSA cannot now explain how the GAD and prudential divisional representatives left the meeting with opposite understandings of what Equitable had been saying to them on this matter.] It was noted that that had not previously been seen as a probable outcome, but had become so following arguments put forward at the House of Lords' hearing. It was also noted that such a ruling (referred to as the third option) would have a profound effect on Equitable's solvency. It was estimated that the cost of paying such additional benefits would be in the region of £1bn to £1.5bn. Equitable had not attempted to renegotiate the reinsurance agreement - which would be invalidated if judgment was given against them - to take account of such a ruling, and the appointed actuary considered that such renegotiation was unlikely to be viable. Equitable would have to fund the additional bonuses from their own resources. In the event of such a ruling, they would immediately announce their intention to seek a partner as it would not be in the best interests of policyholders for Equitable to continue in a weakened financial state, particularly if the investment policy had to be changed to a more conservative one. Though Equitable did not believe that they would then be insolvent [in other words they believed that they would still meet the required minimum margin], they were keen to avoid precipitous regulatory action should the judgment go against them, mainly because that could have a detrimental effect on the value of the business. The prudential division said that they understood the importance of maintaining the value of the Society and would not rush to take remedial action in such circumstances, though they would need to be convinced that a suitable buyer was likely to be found quickly. Equitable considered that substantive sales negotiations could begin with a number of potential partners in August, with a view to completing a sale before the end of the year. If the House of Lords simply upheld the Court of Appeal judgment, Equitable expected to reduce the bonuses payable to GAR policyholders as a class; they did not consider that that would contravene the judgment, although that could lead to arguments that they had ignored the spirit of the House of Lords' judgment.
The prudential division told a meeting of FSA's Executive Committee that the House of Lords' judgment was expected on 20/07/00.
19/07/00
Following the previous day's discussion, the prudential division prepared a note setting out the possible outcomes of the House of Lords' appeal, and the regulatory action that was likely to be appropriate in each case. The note recognised the third option as a possibility which, the author said, "is not something that has been considered previously", but said that it was much less likely than the other two potential outcomes. [FSA say that, according to the author of the note, this reference must be to the court not to the prudential division; as clearly both Equitable and FSA had previously considered it in their scenario planning. FSA's previous scenario planning had mentioned the possibility of Equitable losing the court case badly and Equitable having possibly to consider reducing bonuses for all policyholders, but it had not specifically considered the possibility of the court opining on the apportionment of bonus between the GAR and non-GAR policyholders.] The note said that should the third option become reality, Equitable would only just be able to meet their regulatory solvency margin, with assets of £3.8bn at the end of 1999 to cover a solvency margin of £1.1bn. Though Equitable could adjust their investments to match assets and liabilities more closely, that would result in a reduction in returns to policyholders and a probable loss of market confidence in the company. The company had therefore decided that, in such circumstances, they would seek a partner; it was expected that there would be no shortage of potential partners. (As this information was sensitive it was given only a very limited circulation within FSA, including the chairman and managing director. It was not passed to the conduct of business division.)
20/07/00
The House of Lords' judgment confirmed that Equitable could not apply different rates of bonus depending on whether or not the policyholder took benefits based on GARs. It also ruled out the possibility of paying lower bonuses to GAR policyholders as a class [ring-fencing].
Equitable's Board were told that the consequential additional liabilities to Equitable, as a result of the House of Lords' decision, had risen from the previously estimated £50m to £1.5bn.
Equitable immediately announced that they were seeking a buyer.
Equitable told FSA's prudential division that they planned an immediate cut of 5% in the value of all with-profits policies on
non-contractual termination; no bonus would be allotted for the first seven months of 2000; they said that they expected bonus levels to be restored once a sale had been completed.
GAD advised the prudential division to write to all with-profit insurers, not only those with GAR policies, as the implications of the ring-fencing judgment could go beyond GAR matters.
The prudential division circulated to the conduct of business and legal divisions, GAD and the Treasury, a document setting out the line they intended to take with the press. That said that they were aware of the contents of the judgment and Equitable's response to it; that there may be implications for other companies; and that they would be asking companies for their assessments of the implications, so that FSA could then consider any regulatory implications.
FSA's Board were told of the House of Lords' judgment, and of Equitable's decision to seek a buyer.
From this date Equitable required their sales force to ensure that all new business proposers signed a declaration saying: "I acknowledge and agree that should there be a transfer of the Society's business to a third party or should the Society demutualise during the period of two years from today's date I shall not be entitled to any benefits resulting from such transfer or demutualisation in respect of the policy for which I am now proposing".
21/07/00
In a note to FSA's prudential division, the Treasury said that they thought it likely that they (Treasury) would be asked for a brief on the situation with Equitable. They said that the judgment prompted thoughts on the wider implications for the future development of the life sector, and the effectiveness of the regulator, which were the sort of topics that they would discuss at quarterly meetings. They set out a number of questions concerned with the implications for the industry as a whole, including: whether FSA ought to have done more; whether the guidance on reserving had favoured companies over policyholders; and whether the judgment had changed the regulator's understanding of policyholders' reasonable expectations. The Treasury said that, while they did not want answers at that stage, the prudential division should consider those points and be ready to respond at short notice should that become necessary.
FSA's legal division produced a summary of the judgment, which concluded that the wider implications for other companies with GAR options were unclear; accordingly, while the guidance letter issued by Treasury's insurance division on 18/12/98 would need to be amended in the light of the judgment, and would need to be less positive in its tone, it was not clear at that stage whether substantial amendment would be necessary.
23/07/00
Equitable sent their sales representatives a "first-aid" briefing pack to assist them in dealing with queries from policyholders and prospective policyholders about the House of Lords' judgment and its implications. The pack said that final bonuses had been suspended until the Board met the next week to consider revised rates. The sales force would be briefed then on the implications for new and renewal business. Meantime, new with-profits business could continue to be written on the basis that it could be "cooled off in the unlikely event that investors find the revised terms unattractive". As it stood, the judgment would affect the statutory reserving position which could lead to constraints on investment freedom in the future. However, selling the business would avoid such constraints and "hence the prospects for future investment returns are undiminished". If asked what would happen if no buyer were to be found, the response suggested was that, as recent press articles had indicated, this was unlikely to happen. "It is therefore perhaps unhelpful to speculate on such a hypothetical situation at this stage." A note on meeting with prospective clients set out the standard structure to be followed, which made no mention of the House of Lords' judgment. A concluding note, however, said "Clearly if the GAR issue and demutualisation are raised by the client the representative must cover all the points raised in . the meeting structure for existing clients". All prospective policyholders were to be asked to sign a declaration as to their understanding of their position if Equitable's business were transferred or the company were to demutualise. The note said that the press had taken a broadly consistent line in relation to Equitable's position including that there would be no shortage of potential buyers, with price estimates ranging from £2bn - £6bn; using £4bn as an example the potential average windfall for policyholders would be £2000. However the ruling had led to a reassessment of Equitable's credit rating. [As this was an internal Equitable briefing, FSA did not have access to it.]
24/07/00
FSA reported to the Tripartite Standing Committee the consequences of the House of Lords' ruling against Equitable. They said that there would only be real problems if Equitable could not find a buyer by the end of the year. Currently, however, that problem did not seem at all likely to emerge. The GAR point arose for 20-25 other firms, but FSA had already made most of them reserve sufficient amounts to cover the costs. There might however be some others coming on the market as well as Equitable.
FSA's prudential division told GAD that, in their view, the House of Lords' judgment had no implications for the life insurance industry as a whole. The impact of the judgment on Equitable had resulted from a reduction in assets, as it had rendered void the reinsurance treaty, rather than from an increase in liabilities; that was unlikely to be the case for other companies. They had required companies to reserve fully for GAR options with the same level of reserve being required whether or not differential terminal bonuses were paid. All that had changed was that ring-fencing had been ruled out, which meant that terminal bonuses would increase in the short term, though they could then be reduced; since companies were not required to reserve for terminal bonuses, there would be no need to increase statutory reserves. GAD replied, confirming the prudential division's analysis. They said that, in retrospect, Equitable had acted imprudently in taking credit for the reinsurance and that they had done so probably in the belief, based on the legal advice they had been given, that they would not have to change their bonus policy.
The prudential division provided a briefing on the implications of the judgment to FSA's policy and standards division, who were concerned that it could impact upon a review they were conducting into the mis-selling of personal pensions. The prudential division said that while a sale could not be regarded as an absolute certainty, it had to be close to 99.9%. Equitable saw a sale as the only option, and it was unlikely that they would fail to find a suitable buyer. They said that the provision that Equitable would have to make for pension mis-selling was likely to increase, though the amount of that increase was unlikely to be significant in the context of the other reserving cost measures the company would experience, which could amount to £2bn.
An action plan was circulated within the prudential division, and to GAD and the legal division, under which FSA were to obtain confirmation as to Equitable's solvency and review projections of future solvency; review the 1998 guidance; ask other companies what implications they saw for themselves; and arrange discussions with Equitable about the sale process. [The plan was not copied to the conduct of business division, although it was copied to the chairman and to the managing director.]
26/07/00
FSA's Executive Committee discussed issues surrounding Equitable's position.
Equitable announced changes to bonus rates. With-profits policies would be credited with no growth for the first seven months of the year, but the previous growth rate would apply from 31/07/00. They said that in selecting a buyer, they would be aiming to maximise the value obtained for the benefit of all members and in particular to secure funds to make up the lost growth.
Equitable's appointed actuary wrote to the prudential division setting out the company's solvency position. He said that the revised resilience test 2 had been intended as a relaxation of the reserving standards, but that in Equitable's current circumstances it was in fact more onerous than the former test. He believed the former test [i.e. that applicable prior to the revision of 15/05/00] to provide an adequate margin of resilience as required by regulations. Using the former test, the company had free assets of £225m, after allowing £150m for increased benefits for GAR holders who had already retired. The take-up rate for GAR options had been assumed such that gross reserves for those policies were reduced by less than 5%, in line with GAD guidance. He pointed out that the reinsurance treaty remained in force until three months after the House of Lords' judgment, and that Equitable were discussing the possibility of an amended treaty which would give the same reserving effect. While accepting that the company's position would be unacceptably weak on a continuing basis, he suggested that, in view of the steps that they had taken to strengthen the position, Equitable should be regarded as meeting the required minimum margin.
FSA's prudential division prepared a briefing note for the Treasury in response to the questions the Treasury had raised in their memo of 21/07/00. They said that the guidance given to the industry broadly required companies to assume that virtually all policyholders would exercise their GAR option if it would be to their advantage. In practice many policyholders would not fully exercise the GAR option, because it provided a form of annuity that was unattractive to them. That meant that, although the judgment was likely to result in an increase in the real costs arising from GAR options (as it was likely that the take-up and cost of those options would increase),the reserving costs were likely to remain unchanged, because companies had already had to assume that virtually all policyholders entitled to a GAR would opt for it. The increased cost of meeting those guarantees would therefore arise from companies paying a higher level of terminal bonus, for which they did not have to reserve. Equitable appeared to be unique in the difficulties it was now facing. On the matter of whether the regulator had "got it right", they thought that "On balance, we did not do badly and indeed it would have been difficult for any guidance to be consistent with the full range of judgments that have appeared". The guidance on meeting the cost of GARs would have to be reviewed but it was not clear that it had been "wrong". The emphasis needed to be changed, so as not to appear to suggest that most policies and policyholders' reasonable expectations would allow differential terminal bonuses. However, if the prudential division had been wrong, so too had the actuarial profession, since the Faculty and Institute of Actuaries had gone on record as saying that they fully supported the guidance. The prudential division were not convinced that either the Treasury or FSA could or should have pushed Equitable to alter their bonus practice; that practice had "was not been clearly unlawful", as had been demonstrated by the first judgment and the fact that the Court of Appeal had found against them only by a majority. On the question of policyholders' reasonable expectations the judgment gave some helpful pointers, but also clouded the issue of whether bonuses had to be consistent with those expectations, or whether they were just one of a number of factors to be considered. Overall, they were probably not much further forward in understanding or defining the concept.
27/07/00
FSA's prudential division wrote to with-profits companies seeking their assessment of the implications of the judgment on their businesses.
The legal division circulated some suggestions about how FSA might revise the guidance to the industry. They commented that the previous guidance had given the impression of allowing a wide range of practices, albeit subject to particular circumstances and contract terms; the revised note would need to avoid appearing to justify existing practices and should make clear that any charge for guarantees should be explicit and specific. The prudential division agreed with the legal division's view.
The prudential division agreed that, rather than waste time and credibility in justifying the earlier guidance (which they nevertheless considered to be justifiable), they should take the House of Lords' judgment as an opportunity to issue a new guidance note.
31/07/00
Another life company told the prudential division that the consequences of the Lords' judgment for them were "pretty dire" particularly if the judgment was construed widely. They arranged to meet with FSA to discuss the position.
02/08/00
Equitable wrote to all their policyholders explaining the impact of the House of Lords' ruling. On the loss of seven months bonus, they said that it was intended that that loss would be made good from the proceeds of the sale of the business. They said that, while after the Court of Appeal judgment they had told policyholders that there would be no significant costs imposed on Equitable if the Lords upheld it, in the event the Lords' ruling had gone substantially further and for that reason its impact had been far greater. The ruling had increased Equitable's required statutory reserves, diminishing capital strength and reducing investment freedom. The letter concluded that Equitable remained an excellent business and members would continue to benefit from its many underlying strengths. [The conduct of business regulators obtained a copy of this letter from a policyholder, which they placed on their file.]
04/08/00
Equitable's appointed actuary sent the prudential division copies of their previous correspondence about resilience test 2, and cited some recent figures to demonstrate that the new test was more stringent than the previous test in its impact on Equitable. He also said that discussions with the reinsurer were proceeding for an amended version of the reassurance arrangement and he would give further information at a meeting to be held a week later.
In a further letter the same day, he told the prudential division that Equitable's excess assets at the end of the year were expected to be £200m, if they wrote no new business, and £210m otherwise.
08/08/00
The prudential division asked FSA's enforcement team for an update on two enforcement cases outstanding against Equitable.
11/08/00
At FSA's request, Equitable and their advisers met the prudential division and GAD to discuss the regulatory aspects of the sale process. Equitable said that they intended to provide sales information to interested parties by the end of August and hoped to have identified a buyer by December; they aimed then to complete the sale by June 2001. FSA considered that to be very optimistic, and pointed out that obtaining agreement for a sale would not be straightforward. The prudential division said that they would want to ensure that policyholders' interests were protected and that, while they would give priority to the regulatory aspects of the sale, they had limited resources and might not be able to consider proposals as quickly as Equitable would want them to. Equitable said that compensation would be due to policyholders and they estimated the cost at £150m; the appointed actuary said that, at worst, it could amount to £350m. Equitable had negotiated a new reinsurance agreement to provide cover when more than 60% of policyholders opted for the GAR; even after taking account of that, however, they had explicit assets of only £1.58bn to cover a required minimum margin of £1.19bn. That figure had been arrived at using the old resilience test 2, and Equitable said that application of the new test would be likely to reduce the Society's free assets by £600m; they agreed to provide FSA with monthly solvency reports.
14/08/00
Equitable met a group of policyholders and according to members' notes of the meeting, told them that, while Equitable met the solvency rules, with its present range of assets Equitable could not pass the [second] new resilience test. The members were also briefed on the alternative courses of action that had been considered by Equitable's directors. [It would appear that the regulators were not aware of this meeting at the time. The copy of the notes held in FSA's conduct of business division files had been sourced from the internet and was dated 08/10/00.]
[Equitable subsequently told my staff through their solicitors that, if such a meeting took place, none of the relevant Equitable officers were still with the Society. The current appointed actuary had confirmed that it seemed unlikely that such officers would have made such a statement and indeed, current officers had no reason to believe that Equitable would not then have been able to meet the new resilience test 2 in the form in which it had been published.]
23/08/00
An internal note from FSA's prudential division warned supervisors that a number of companies were currently being restructured in ways involving exercise of due diligence by a prospective new controller. Companies would need to consider whether the Lords' judgment was likely to have a significant effect on the due diligence already performed and the financial position of any of the companies involved.
FSA's Executive Committee met. There was some discussion of the Equitable case, and the prudential division said that they were preparing a paper for consultation on the impact of the judgment.
24/08/00
The House of Lords' judgment and its implications were discussed at the eighth bilateral meeting between prudential and conduct of business divisions. The prudential division said that the judgment would have implications both for Equitable and more widely among the insurance industry. They said that it was hoped that a buyer would be identified by December, and that the process of demutualisation should be completed by June 2001, although whether this was achievable would depend on a number of factors; in the meantime, Equitable were just covering their solvency margin. The judgment was not considered to have solvency implications, as the level of reserving had not been affected, although it was noted that some companies would experience higher real costs. Equitable had experienced a weakening of their financial position only because the reinsurance had been conditional upon their continuing to pay differential terminal bonuses, and so had been terminated following the judgment. The reinsurance treaty had been renegotiated, which had given the company "a bit more breathing space"; however, the solvency position "remained tight". [According to the Baird Report, as a result of that meeting, FSA's conduct of business division concluded that Equitable remained solvent and need not therefore be required to make specific disclosures to new policyholders.]
25/08/00
Equitable's advisers sent to companies who had expressed interest in acquiring Equitable an information memorandum to assist them in their preliminary assessment, along with information on the related sale process.
01/09/00
FSA's prudential division prepared a paper recommending that the Insurance Supervisory Committee should grant Equitable's application [of 27/06/00] for a section 68 order permitting a future profits implicit item of £1.1bn. The paper said that, despite losing in the House of Lords, Equitable were still solvent, but they had been weakened to the extent that they were seeking a buyer. The prudential division had routinely granted such concessions, provided that they had been satisfied that the calculation provided for in the regulations (which, they said, provided a conservative estimate of future profits arising from business already written) had been correctly carried out. By that calculation, Equitable would be entitled to an implicit item of £3.3bn, but were seeking only a third of that, and were unlikely to depend on the implicit item to cover the required minimum margin. Equitable's excess assets at the end of June 2000, "re-stated post judgment", amounted to £1.39bn. Equitable's profits were expected to improve by the end of the year. Detailed calculations provided by Equitable had been reviewed and approved by GAD, who were fully aware of the context in which the concession would be granted. While a number of uncertainties could affect Equitable's balance sheet, those should not significantly affect the future profits implicit item calculation.
Equitable's appointed actuary wrote to the prudential division with a monthly solvency update to 31/07/00 showing excess assets of £1.3bn. He enclosed copies of the signed addendum to the reinsurance agreement and provided information about Equitable's investments which GAD had asked for at the meeting on 11/08/00.
The prudential division asked the enforcement team for a response to their enquiry of 08/08/00. The enforcement team replied that work on one case - the pensions review - was unlikely to begin for several weeks owing to other priorities. They had received Equitable's initial response to their findings in the second case - pension fund withdrawals - and were expecting a further response by 07/09/00; they said that the initial response had not been extensive but had contested some of their findings.
05/09/00
The prudential division circulated a draft paper, to be issued to members of the FSA Chairman's Committee, setting out the background to, and objectives for, issuing a consultation paper on draft guidance to the industry on the FSA's approach to interpreting the implications of the Lords' judgment.
07/09/00
Treasury officials told the then Economic Secretary that FSA wanted, by the end of September, to issue a consultation draft of new guidance to those companies that had sold GAR products about the implications of the House of Lords' judgment and what, in the light of that judgment, FSA now understood to be policyholders' reasonable expectations.
08/09/00
The conduct of business division gave the prudential division some immediate reactions to their draft guidance for the industry. They said that they were unable in the short time available to provide a considered response to all of the points.
11/09/00
The chairman of the Insurance Supervisory Committee told members, by e-mail, that Equitable's section 68 application involved a "fairly standard request" for a concession for a future profits implicit item. He said that the prudential division's paper (of 01/09/00) made clear that Equitable's request was well within normal parameters, and he saw no difficulty in agreeing to the recommendation. He added, however, that the implicit item was an important aspect of Equitable's overall financial position and, given the company's high profile at the time, some members might wish to discuss the paper. He asked members to let him know by noon that day if they wanted to discuss the application. One member of the Committee replied pointing out that the amount of future profits that Equitable could take into account in their December 2000 return could not exceed the amount that could be supported were a new section 68 application to be made at that time. Equitable were expected to show a sharp fall in surplus for 2000 because of the judgment, and so in practice if the application were granted, they might in any event be unable to use the full amount in their returns. However, that was not a reason to refuse the application. The Committee approved the application the same day without meeting.
12/09/00
The prudential division told the FSA managing director that there were strong regulatory reasons for putting out some early guidance to the industry on FSA's view of the implications of the Equitable judgment. They had been unable to clear a draft internally in time for it to be discussed at that day's Chairman's Committee, but they still hoped to seek Board approval in September.
The prudential division told Equitable that they had asked the Treasury to issue a section 68 order in respect of the future profits implicit item for which they had applied. They went on to point out that the amount of the implicit item actually shown in the annual return due on 31/12/00 could not exceed the amount that could be supported by a new application submitted with that return. They also said that, were Equitable to demutualise, the company taking over the business would not be able to take advantage of any surplus that had accrued in Equitable to generate an implicit item for itself.
13/09/00
The Treasury granted Equitable's request of 27/06/00 for a section 68 order for the lesser of £1.1bn or 50% of the full amount of future profits.
19/09/00
The inaugural meeting of FSA's Firms and Markets Committee noted a FSA decision on another life insurance matter. No reference was made to Equitable.
20/09/00
The seventh quarterly meeting took place between the Treasury and FSA. The Treasury pointed out that Equitable were advertising for new business. FSA said that Equitable's difficulties did not affect their solvency, only their freedom to invest. It was noted that a number of other companies followed practices similar to that of Equitable; FSA said that they did not see that as a huge problem in the short term because the solvency of the companies would not be affected, although there was concern about the ramifications of the judgment on those companies. There was some discussion of FSA's proposal to issue guidance to the industry, and they undertook to keep the Treasury informed on what they were doing in that regard.
21/09/00
At a meeting of FSA's Board, the relevant managing director reported that the House of Lords' ruling went further than simply saying that Equitable could not adjust terminal bonuses for those who opted for a GAR so as to reduce the value of the guarantee. It had also said that Equitable could not ring-fence GAR business from other with-profits business for the purpose of setting the terminal bonus. The extra costs of the GARs therefore had to be spread amongst all policyholders in the fund. This had potentially serious implications for the reasonable expectations of other
with-profits policyholders. Reports to FSA from the industry indicated that there was considerable confusion and uncertainty as to how they should respond. Work was therefore in hand to prepare guidance for the industry. The Board was content that the guidance be published in advance of the next meeting, provided that the executive directors were satisfied with its adequacy.
Equitable sent their sales representatives further guidance on advice and sales issues arising as a result of the House of Lords' ruling. If clients asked whether Equitable was secure, the representatives were advised that the following simple statement might suffice to meet concerns that Equitable might be unable to meet a claim: "All UK insurance companies are subject to strict supervision by the regulatory authorities. They would not allow any company to continue accepting new business if they were not satisfied that it could meet its liabilities". New members were to be told that the sale of Equitable would provide funding sufficient both to restore policy values and preserve the investment freedom of the with-profits fund for the future. Along with existing members, all new members were likely to benefit in general terms from the sale, for example, from the greater investment freedom a sale would bring. [Again, as this was an internal briefing it was not made available to the FSA.]
22/09/00
GAD told the prudential division that they had reviewed copies of the addenda to the reinsurance agreement and considered it satisfactory. They went on to say that, without the future profits implicit item, Equitable would have excess assets of just £300m, and that the resilience reserve, which they took to be calculated on the old basis, was substantial at £1.8bn. However, they had no questions to raise on the figures provided at that time.
04/10/00
A note of a FSA Firms and Markets Committee meeting said that another company had alerted the Treasury to their potential difficulties in relation to GARs.
FSA's public enquiries unit, acting on advice from the prudential division, sent the conduct of business division a copy of a letter addressed to Equitable, which had been copied to FSA, in which the writer was complaining about the nature of Equitable's advertising in the light of their current situation. The conduct of business division were asked to comment on whether Equitable's advertisements were misleading. They replied that, while they could see why the statements made would cause considerable annoyance to Equitable policyholders, nevertheless the GAR issue should not overshadow Equitable's many other business activities. They said that Equitable had achieved a record of success and had a good reputation; while the division had not seen the advertisement in question, it appeared that the claims were based on the past rather than the current position. Overall the conduct of business division did not think they could support the call for the advertisements to be withdrawn.
06/10/00
Following an approach by one of the bidders for Equitable (bidder A), the Office of Fair Trading asked FSA's prudential division if they had any thoughts or concerns about the potential merger.
The prudential division noted that Equitable had received "three serious offers to buy the group". Equitable's appointed actuary had told them that the bids were high enough to enable with-profit policyholders to gain restitution for the investment growth they had lost for the period 1 January to 31 July 2000 with additional goodwill on top.
09/10/00
The prudential division proposed a meeting with GAD and the conduct of business division to discuss their response to the request from the Office of Fair Trading and any wider issues arising from the proposal.
Equitable's appointed actuary provided the prudential division with an estimated solvency position as at 31/08/00 showing excess assets of £2.165bn. According to his covering minute, the huge change from the July position was due to the markets having strengthened in the interim, and he provided some analysis of the sensitivity of Equitable's solvency to equity and gilt yield movements. He also provided a copy of a letter sent to policyholders regarding the proposed compensation scheme.
In an internal e-mail, the prudential division commented that, whilst there was some comfort to be derived from the fact that there were some proposed bidders with reasonable offers on the table, it would have been better to see "more big hitters in the frame".
11/10/00
FSA's Firms and Markets Committee met. The Committee heard that Equitable had received three serious offers and that the appointed actuary believed that the bids were sufficiently high to enable restitution to policyholders for the loss of growth in the first part of 2000, together with an additional element for good will.
12/10/00
FSA told the Office of Fair Trading that the main issue for FSA, if the company concerned proceeded with the proposed acquisition, would be how the acquisition was financed.
The conduct of business division received a copy of a letter sent to the Advertising Standards Authority, which enclosed a copy of members' notes of the meeting that had taken place between representatives of a group of policyholders and Equitable on 14/08/00. The note said that Equitable had explained that regulations [i.e. the 1994 Regulations - paragraph 22] required Equitable to be "reasonably certain" of being able to meet their guaranteed liabilities, regardless of likely variations in the values of their investments. The note said that there were two tests; a simple solvency test to show that the current value of assets was at least equal to the total liabilities; and resilience testing, to show whether solvency would still be maintained if adverse conditions in the financial markets reduced the value of their assets. According to the note, Equitable had said that with their present range of assets, they could not pass the resilience test. They had told the members that with their presently high proportion of assets in equities, they required an injection of £3bn in new funds to remain resilient. Considering the action which might be taken, Equitable had said that doing nothing was not an option because, given the statutory rules on life companies relating to investment freedom, "whilst the solvency criteria could be seen to be satisfied resilience could not". They had told the members that the advice they had received indicated that selling the business would not only restore resilience to the balance sheet, but would enable them effectively to repay the bonuses withheld and to provide a small windfall payment. The correspondent said that, as the meeting had demonstrated that Equitable were at present unable to satisfy government requirements to enable them to carry on business as usual, current investors were being misled about the returns they might expect to receive. The correspondent asked the Authority to prevail upon Equitable to withdraw its current advertising campaign and complete no new business without full disclosure of the position to potential policyholders. [It is not clear what action, if any, conduct of business division took as a result of the letter and enclosures.]
17/10/00
Having reviewed Equitable's letter of 09/10/00, GAD sent a memorandum to the prudential division pointing out that, while solvency cover was adequate, if equities were to fall by 15% Equitable would be unable to meet the required minimum margin. They said that that corresponded to a fall in the FTSE 100 index to around 5,700 and, since the index had recently been around 6,200, close monitoring was required.
FSA's Firms and Markets Committee met. The relevant managing director told the Committee that many companies appeared to be concerned about the implications of the House of Lords' judgment. He said that life insurers were receiving confused legal advice and there was an expectation that FSA would produce guidance on the issue, though it was proving difficult to draft any helpful guidance. FSA's press office, however, were not receiving enquiries about that or about the proposed sale.
FSA's chairman, managing director, the director and other prudential division staff together with a FSA lawyer met to discuss Equitable. They noted the concerns of another company whose business seemed to be significantly affected by the judgment. The meeting agreed that FSA should aim to produce a best attempt at advice on what the judgment meant and how FSA interpreted it in relation to the regulator's responsibilities. A discussion would be held with those counsel who were known to be advising life companies.
19/10/00
The FSA managing director reported to the Board that, despite difficulties in assessing the level of liability arising from the House of Lords' judgment, Equitable had received three serious offers. The appointed actuary had indicated that the bids were sufficiently high to enable repayment to with-profits policyholders of the loss of growth for the period 01/01/00 to 31/07/00, with an additional payment for goodwill. FSA would need to see the detailed bids and structure to determine whether the with-profits funds were strong enough to secure the desired restoration of investment freedom going forward. He said that FSA were preparing draft guidance on the implications of the House of Lords' judgment; companies were considering the implications of the judgment and it was apparent that there was a considerable amount of uncertainty as to how they should respond.The proposed guidance would be aimed at encouraging a degree of consistency. The minutes noted that the managing director had said that the situation was however becoming more complex and the giving of guidance more difficult.
FSA's prudential division and GAD attended a meeting with a company that was proposing to buy Equitable, at which various aspects of the proposed bid were discussed. The company said that they hoped by early November to have a full proposal for financing their intended purchase, and would then discuss the matter further with FSA.
FSA's chairman wrote to the director of the prudential division about press reports that two bidders might be preparing to use "free estate money" to acquire Equitable and that FSA would need to approve it. He asked if that was a possibility.
20/10/00
An officer of FSA's prudential division replied to the chairman, copied to the managing director and the director, saying that three named companies were still in the running to acquire Equitable. Any proposal would require FSA approval. At least two of the potential bidders could seek to use free estate to help finance their bids, but FSA would need to ensure that the interests of their own policyholders, as well as those of Equitable, were protected.
25/10/00
FSA's prudential division attended a meeting of the Office of Fair Trading merger panel to discuss one of the potential bids for Equitable.
FSA's Firms and Markets Committee met but did not refer to Equitable.
27/10/00
Equitable replied to a policyholder's complaint about a current advertisement. They pointed out that their past performance was a matter of record; that they remained solvent; and that the "temporary" loss of bonus was expected to be made good following a sale. They went on to say that, in negotiating the sale, they intended to ensure that the House of Lords' judgment would have no long-term adverse effect on policyholders' expectations. In conclusion, they expressed the view that the advertisement met the relevant FSA and Advertising Standards Authority rules. [According to the Baird report, FSA's conduct of business division were reassured that Equitable were reviewing the content of their advertisements in the context of PIA rules, and that Equitable considered them to be fully compliant.]
FSA's enforcement team outlined to the prudential division the findings of a review into Equitable's sales of pension fund withdrawal contracts. They said that they were minded to recommend disciplinary action against Equitable consisting of a public reprimand, a fine in the region of £500,000, and an order to conduct a review of past business. Such a review was likely to result in administrative costs of around £11m to Equitable, and redress which they estimated at £30m for policyholders.
30/10/00
Equitable's appointed actuary provided the prudential division with the solvency figures for the end of September, which showed excess assets as £1.14bn.
31/10/00
Bidder A assured FSA that they were not behind a rush of recent press reports which seemed to "talk down" Equitable's value, and they still saw the Equitable sales force as a very worthwhile acquisition. However, they believed that the shortfall in Equitable's funds was greater than Equitable themselves had estimated. The company expressed concern that the wording of Equitable's policies allowed GAR policyholders to increase their contributions to the fund, to which the guarantee would attach, thereby increasing the fund's liabilities to the detriment of other policyholders in the fund. They said that they were investigating whether and how that liability might be capped, but said that they were more pessimistic on the issue than were Equitable's directors. They were not yet convinced that they would wish to make a bid.
FSA's Firms and Markets Committee met. FSA's chairman expressed concern over press reports that there was little interest in purchasing Equitable. He saw a risk that FSA could be presented with a scenario where only one bidder remained, and the purchase depended on FSA accepting certain proposals as to funding of the purchase which he would regard as controversial. It was agreed that the prudential division would talk to the bidder in question about their proposals. While only three bidders remained, it was still thought likely that "a good sale" could be achieved.
FSA's conduct of business division sent the prudential division copies of correspondence with members of the public about whether, in view of the present uncertainty, the with-profit fund should be marketed. FSA's conduct of business division said this was "way beyond PIA advertising rules".
Equitable's regulatory solvency position was declared as excess assets of £1.08bn including a £1bn future profits implicit item.
01/11/00
The relevant director reported to the FSA chairman his conversation of the previous day with the chief executive of bidder A. The chairman, in a manuscript note dated 31/10/00, commented that this was a useful conversation but it did not "lower his worry level about Equitable" and that an early discussion on the matter was very much indicated.
02/11/00
In a confidential briefing note to the chairman, the director referred to the concerns raised by the discussion with bidder A. He said that Equitable's regulatory solvency cover was being monitored monthly but remained fragile. A stock market fall to a FTSE 100 level of about 5700 could lead to them breaching the regulatory solvency margin cover. If that happened FSA would need to consider the position carefully. However, a decision to stop Equitable writing new business would finish them off as a sellable enterprise because the sales force was of crucial importance. It was hard to see that that would be in the interests of current [FSA emphasis] policyholders - but the position of those not already in would have to be considered carefully too. There were also some reserving issues which FSA still needed to "bottom out" with Equitable. These included the extent to which GAR policyholders could top-up further their policies. The exposure could be significant. It appeared that, for reasons of sensitivity, Equitable had not yet sought to close this option down, but they expected to do so at some point. FSA would have to explore this with Equitable, and the cost implications if they could not.
GAD suggested to the prudential division that one possibility for dealing with the top-up issue would be that FSA might issue an order preventing Equitable from accepting more than a specified sum in incremental payments. GAD said that that would cap the liability arising from GAR options, and the regulator could then ensure that Equitable were fully reserved for that liability. (A manuscript comment on the note read "grounds" and "challengeable by court?".) GAD said that that would be less drastic than stopping Equitable from writing new business which, they suggested, would almost certainly end any chance of a sale. They suggested that Equitable might then seek court approval to limit the liability on policies containing GAR options on the grounds that the interests of policyholders without such options would otherwise be prejudiced.
(The prudential division subsequently learned that Equitable had already obtained legal advice to the effect that, while they could limit top-up payments in certain circumstances, their ability to do so was restricted. The FSA's legal advisers subsequently advised the prudential division in similar terms. Equitable considered that that was unlikely to be of any significant benefit.)
FSA's prudential division discussed with the Office of Fair Trading a request by bidder A for confidential guidance should they bid for Equitable. Officials there had said that it seemed likely that the bidder would be given "favourable guidance" as any bid looked unlikely to be referred on competition grounds. This did not, however, provide clearance for any subsequent bid.
03/11/00
A meeting took place between Equitable, FSA's prudential division and GAD. FSA's record of the meeting noted that: Equitable were close to finalising a compensation scheme for GAR policyholders whose policies had matured since 01/01/94; Equitable's auditors, having considered the question of GAR policyholders increasing their benefits, felt comfortable with Equitable's figures, and believed that explanations given as to the basis for reserving had provided some reassurance to bidders; the prudential division had requested a copy of the auditors' valuation report (of which they had been aware since 01/09/00); and finally, that Equitable's appointed actuary had said that he was not aware that any bidder had raised concerns about reserving issues.
A note of the meeting prepared by GAD said that the aggregate value of the recent cut in bonus rates amounted to £1.5bn and that was expected to be sufficient to cover the cost of paying GARs on full asset shares. That meant that new policyholders should not have to meet the cost of GARs, although they would be joining a very weak fund. Equitable had set up a provision of £550m (all but £200m of which was to be met from reinsurance) against liabilities arising from additional payments made into policies containing GAR options; they were to review that for their year 2000 regulatory returns. Equitable had estimated that that liability might, at worst, increase to around £500m, net of reinsurance. GAD noted that Equitable did not appear to believe that the issue was a serious concern for potential bidders. Equitable were currently applying a variant of the resilience test recommended by GAD. They could either present this publicly (which might give rise to some adverse comment) or seek a section 68 order (concerning valuation interest rates) which would allow them to apply the standard resilience tests. If no sale were to take place Equitable would almost certainly have to stop writing new business, and very probably have to rearrange their investments to a more defensive position to protect against liquidation in the event of a substantial fall in equity values. GAD said that they believed that Equitable were currently covering their minimum capital requirement, but had very little room for manoeuvre in the event of a modest fall in equity values. Equitable had told them that the aggregate value of the proposed compensation scheme for policyholders who had retired since 1994 was £200m.
In an internal e-mail the prudential division referred to complaints that they had received which alleged that Equitable's advertising was misleading. The prudential division took the view that Equitable remained solvent and therefore, as long as the division had neither the grounds nor the intention to stop them writing new business, there was no reason why Equitable should not continue to advertise. A draft reply to respond to complaints had been prepared on that basis. It said: "As regulator, we do of course monitor the financial position of insurance companies carefully. However, we understand that Equitable continues to be solvent for Companies Act purposes and indeed continues to maintain the required margin of solvency over its liabilities as required under the Insurance Companies Act 1982. As the Equitable continues to be a going concern, complying with the relevant regulatory requirements, we do not share your view that it should be prevented from marketing its products, which could be damaging to the business. Nor do we believe that at a time when the statutory requirements continue to be met, and when there is a realistic chance of a successful sale of the business, that the newspaper advertisement inviting potential customers to request additional information from the company, is misleading."
In an e-mail, which circulated the draft reply and was copied to the conduct of business division, the prudential division said that to prevent Equitable from marketing their products could be damaging to the business and, as there was a realistic chance that Equitable would find a buyer, advertisements inviting potential customers to seek further information were not misleading. The conduct of business division said that they had received similar complaints and that they shared the prudential division's view that it would not be reasonable to stop Equitable advertising, adding that it would probably be illegal to do so, although "If we believed it was in breach in some way of its prudential requirements, that could affect the position".
06/11/00
At a meeting with the prudential division and GAD, another potential bidder (bidder B) expressed concern that Equitable's current future profits implicit items might be withdrawn following a sale. They asked about FSA's attitude to financial reinsurance instruments and were told that FSA had some concerns about such arrangements where they took advantage of regulatory arbitrage (paragraph 29); bidder B said that Equitable's reinsurance agreement fell into that category; they were also concerned that the reinsurer had the right to terminate the arrangement if Equitable became insolvent. Bidder B asked why Equitable had been able to include in their resilience reserve a Zillmer adjustment (paragraph 30) which effectively added ½% to the investment return. They expressed concern that, due to what was described as Equitable's precarious statutory [regulatory] solvency position, Equitable might "go through a period of statutory insolvency" before making a recovery. They asked whether, were that to be the case, any relaxing of the regulatory requirements would be possible. GAD told them that, while it was highly unlikely that FSA would permit any such relaxation, it might be possible to overcome the problem were Equitable to remain a mutual. Bidder B said that the GAR issue, along with Equitable's practice of allowing policyholders to take retirement benefits at any age between 50 and 75, had created a deficit that was potentially larger than could be met by any goodwill payment that they might offer. They were also concerned that, by including an illustration of terminal bonus in the annual statements provided to policyholders, Equitable might have created an expectation on the part of those policyholders. Bidder B discussed with GAD and the prudential division various means by which they might provide capital support for Equitable, were a sale to go ahead. The prudential division noted that bidder B had significant concerns about the risks they would be taking on were they to acquire Equitable.
In a briefing to the chairman for his appearance before the Treasury Select Committee [on 07/11/00], the director reiterated the points made on 02/11/00 about the shortfall in Equitable's funds possibly being greater than they themselves estimated. He added that Equitable could face significant exposure to GAR policyholders topping up their polices further. He noted that solvency was reported to FSA monthly and confirmed that Equitable continued to maintain their statutory margin of solvency although solvency cover remained fragile, and a fall in the FTSE 100 to about 5700 could lead to them breaching the regulatory solvency margin. However a decision to stop them writing new business would finish Equitable off as a sellable enterprise because the sales force was of crucial importance; this would not be in the interests of policyholders. The director added that it was discomforting to see full page spreads in The Times exhorting the benefits of Equitable and all the awards they had "won" whilst at the same time there was real uncertainty about their financial future. There had been complaints that some of the claims made were misleading. FSA's prudential division would probably need to look into these claims as both the Advertising Standards Authority and the FSA's conduct of business advertising team claimed that the nature of the complaints made by policyholders were beyond their regulatory remit. The director said that the FSA's current public line was that the company remained authorised to conduct business and was therefore entitled to market itself. If FSA received any complaint about advertisements misleading consumers they would investigate the complaint on its own merits.
07/11/00
In response to a query from the managing director about the possible impact of recent equity price changes, the director pointed out that the required solvency margin included the requirement to meet a resilience test. Even if Equitable were at 100% solvency cover, which would equate to a FTSE 100 level of about 5700, they would still be able to meet a further 25% fall in the markets before having to close to new business.
The director also told the managing director in a further exchange of e-mails that the Chairman's Committee would need to take their own view of the draft guidance and might wish to be courageous in what they decided. On resilience testing he said that an overnight drop of 35% in equity markets would be difficult and a steep but not overnight fall would create problems if insurers were under pressure to move rapidly out of equities and into gilts, of which there was already a shortage. Equitable would need to move in that direction ahead of most of the market which would help them, but they were a big enough player to have some influence on the gilt market on their own.
08/11/00
An internal prudential division minute said that they had learned from FSA's press office that Equitable had apparently decided not to continue with their advertising campaign. FSA were sticking to the press lines already given and when asked if FSA had intervened, had simply said that FSA did not discuss dealings between themselves and regulated firms.
09/11/00
The managing director told the Tripartite Standing Committee that FSA were seeking guidance from lawyers on whether they could issue guidance to insurers on limiting the damage to the industry that could be caused by the Lords' judgment on Equitable. Asked about the implications for other insurers, the managing director said these would depend on how narrowly the judgment could be interpreted.
Bidder B told FSA's chairman that, although they had been very interested in acquiring Equitable, they had reached the view that the financial position was considerably worse than they had first thought, and perhaps rather more doubtful than FSA had been led to believe. While they had not entirely ruled out any possibility of proceeding, they expected soon to tell Equitable that they did not wish to do so.
10/11/00
FSA's Firms and Markets Committee met. There was some discussion about the draft guidance that FSA had produced on the Equitable judgment but no other specific reference to Equitable.
FSA's prudential division subsequently told their legal division, in an e-mail, that FSA's chairman had told the Committee that FSA should not consult informally with companies on the proposed guidance - as they had intended to do - since the guidance was capable of being market sensitive and limited informal consultation might therefore be improper. The next step would be to consider a draft internally and put it to the Chairman's Committee. The prudential division said that it was still their aim to put out the guidance for full public consultation by the end of the month.
13/11/00
FSA sought Counsel's advice on their proposed guidance.
A paper prepared by FSA's prudential division pointed out that, in respect of GAR options, reserving costs may differ substantially from the real costs. That was because FSA required companies to reserve on the assumption that virtually all policyholders would take the guarantee if that was higher than the current market rate, whereas in practice many would not do so. The paper went on to say that the Equitable case had added to concerns already raised about the opacity of with-profit policies, where typically up to 60% of the benefits were determined by the directors. Consideration was being given to the question of whether such policies should be redesigned to be more customer friendly.
An internal note recorded that FSA had successfully encouraged journalists who had contacted them about Equitable's position not to mention possible intervention by FSA on the grounds that "a profitable run-off was the worst thing that could happen..[there was] no disaster in the making". The note commented that there had also been several press articles criticising Equitable's current advertising campaign which cited their "wonderous past" without mentioning the more difficult present. The note concluded that it was understood that FSA had spoken to them and they were withdrawing their campaign.
14/11/00
FSA learned that although Equitable had withdrawn their new advertising campaign, they had not stopped advertising altogether. In a note of a telephone call made to Equitable to check on the position, FSA's prudential division said that they had told Equitable that they had been giving a "fairly robust line" to people who approached them, namely that the company was solvent and continuing to trade, so it was not a matter for FSA to be concerned about. The note concluded, however, that it was to be hoped that any future campaign would recognise the sensitivities and be presented with more tact.
An internal discussion paper was circulated by the prudential division, copied to GAD and the legal division, setting out how each of the possible outcomes of the bidding process might be handled and what the FSA's involvement should be. It noted that potential bidders had serious concerns about their own possible exposure to the seemingly unlimited exposure of Equitable to certain liabilities, including the apparent right of GAR policyholders to increase their cover, although Equitable had said that that exposure was less significant than had been suggested. The note also examined the regulatory implications of certain suggestions made by potential bidders as to how they might protect their own shareholders from an unacceptable degree of risk on acquiring Equitable. The prudential division concluded that, at that stage, there were no grounds for considering action on the basis of insolvency, as Equitable were able to meet their contractual obligations.
15/11/00
FSA's prudential division and GAD met another potential bidder, bidder C, to discuss how they intended to finance their proposed bid.
At a meeting with bidder A there was discussion about the possibility of ring-fencing GAR liabilities and limiting increments on GAR policies.
Bidder B told FSA's prudential division that they felt that, in the light of the results of the due diligence process they had carried out, it would not be worth taking Equitable "at any price". They said that, even if the whole of any purchase price were to be paid in to meet the shortfall in Equitable's funds, a great many policyholders would remain dissatisfied, which would make it impossible to continuing selling to them or to new policyholders under the Equitable name. They also said that some among the current policyholders were expecting a restoration of foregone bonuses and perhaps a demutualisation bonus, expectations it would be quite impossible to meet. They offered to take FSA through the actuarial assumptions they had made in their due diligence process. FSA's chairman told the director, in a manuscript addition to a note from the managing director, that he thought it would be helpful to understand bidderB's view. The prospects [for a sale] looked dimmer by the day and FSA needed to be bending their minds to what to do if no buyer was forthcoming or only on terms which were difficult for FSA to accept.
16/11/00
Commenting on the discussion paper of 14/11/00, GAD said that if no buyer were found, and Equitable intended to remain open to new business, they believed FSA would have to require Equitable to commission an independent investigation into their viability to write further business. They said that Equitable were very close to not covering their margin of solvency. There were uncertainties in, for example, the viability of the reinsurance agreement and in how financially resilient Equitable actually were - they were already "unable" to meet one of the resilience tests; it would be difficult to arrange a rescue by another insurer should they become technically insolvent. [GAD told my staff at interview that "unwilling" was intended rather than "unable", and that "unable" was in fact inaccurate.]
The managing director submitted a report to the FSA Board which said that there were three potential bidders for Equitable but that the "due diligence process had revealed some concerns about how far liability for guarantees can be capped" since the guarantees appeared also to apply to some future premiums. He said that FSA were exploring with Equitable the implications of this for the sale and for the expectations of future policyholders if Equitable continued to write new business.
Equitable's appointed actuary told GAD that their regulatory returns for 1999 assumed only 85% of benefits would be taken in GAR form. He said that the reserves held for contracts incorporating GAR options were 95.7% of the reserves that would be held if a 100% take-up rate were assumed. He listed a number of factors which he said influenced policyholders in deciding not to opt for the GAR, including the operation of Equitable's differential terminal bonus policy. While he accepted that that factor was no longer relevant, he said that in the three months that Equitable had been operating their current final bonus system, the take-up rate for GAR options had been 44%. He said that the GAR reserve was attributable between paid-up benefits and future premiums in the ratio of 3:1. Although the future premium assumption would need to be reviewed at the December 2000 valuation to reflect the experience of 2000, there had at that time been no significant up-turn in premiums since the Lords' judgment. He enclosed three reports: components of an Actuarial Appraisal of Equitable Life as at 31 December 1999, dated 25/08/00; Financial Projections of Equitable Life, dated October 2000; and Stochastic Financial Projections of the with-profits business of Equitable Life, dated 08/11/00. The reports had been prepared by the Equitable's actuarial advisers (from the same firm as their auditors) as part of a package to be provided to bidders. The appointed actuary raised a specific point about the approach taken to reserving in the conditions of the resilience tests. He said that Equitable's non-standard approach to resilience testing stemmed from the unusual nature of their recurrent single premium contract. He said that some of the prospective purchasers wanted confirmation that GAD considered Equitable's practice of making a charge of ½% on accumulating with-profits pensions business to be reasonable, and would not require a change to that practice following the sale of Equitable. The appointed actuary said that the implication of the method he had applied was that there would be earnings in excess of the valuation interest rate used. He said he believed Equitable's approach was reasonable and invited GAD's comments.
In an internal memo FSA's prudential division said that one of the three potential bidders had withdrawn and set out the issues that had arisen during discussions with the two remaining potential bidders. They said that both appeared genuinely interested and were aiming to submit bids by 27/11/00, although they had both had reservations about continuing liabilities and potential compliance issues. One identified the main problem as the open-ended nature of Equitable's GAR liabilities. They had therefore drawn up proposals for the structure of Equitable after acquisition that would effectively cap any liability arising from policyholders with GAR options making additional payments under their policies. That would involve closing to new business Equitable's with-profits fund and creating separate GAR and non-GAR sub-funds. The GAR sub-fund would then comprise the reserves already calculated by Equitable as being needed to meet the GAR option liabilities, plus a goodwill payment for acquisition of the business; policyholders would still be able to make further payments, but the costs arising from those payments would have to be met from within the fund and could not be subsidised from the non-GAR fund. FSA's prudential division noted that both they and the bidder were seeking legal advice on the proposal. A manuscript endorsement by the chairman, dated 17/11/00, said that one bid (B) looked more promising, though he did not understand how they made the sums add up. The propositions by the other bidder (A) looked fraught with difficulty for FSA. Bidder A's proposals to use their estate to finance a deal was a dangerous issue and one where FSA had to proceed carefully.
FSA received a report by Equitable's actuarial advisors restating the 1999 year end position. They said that the impact of the new resilience test 2 was considered to be too strong and could in practice be mitigated by a release of prudent margins. The overall impact of the restatements, assuming a cash injection of £3.5bn, was for excess assets to increase from the actual position of £2.7bn to a restated position of £5.2bn. They pointed out that other approaches to reserving were possible which would lead to a need for higher or lower reserves, and they cited a number of examples.
17/11/00
FSA's prudential division wrote to two potential bidders who had expressed concern that Equitable's future profits implicit item might be withdrawn following a sale. They said that while FSA would be prepared to consider granting such a concession to the company taking over Equitable's business, they would have to consider any such request on a case by case basis.
The prudential division told the conduct of business division that if one of the bids was successful, those with GAR policies would find making top-up payments an attractive option, and this was expected to shift the GAR liability significantly upwards. As things stood, other policyholders would have to meet those additional costs, with the non-GAR policyholders being likely to end up subsidising the GAR policyholders. Bidder A were asking whether this would be regarded by FSA as mis-selling to those policyholders who did not have GARs.
The prudential division told the Chairman's Committee that the industry had made clear a strong wish to have FSA guidance on the implications of the Equitable judgment as quickly as possible, to remove uncertainty from the market place. They provided them with a draft guidance note.
20/11/00
A conduct of business official replied to the prudential division that the minimum reasonable expectation of existing policyholders for new sales would be asset share. If asset share could not be promised then the warning that a buyer could get back less must be disclosed and could make Equitable unsellable. In other words, if the position was that bad, "the closed fund" option might be the only option.
FSA's enforcement director told the prudential and conduct of business divisions, in the context of comments on the draft industry guidance, that the fact that a company had ended up in a position in which it had either to breach its contractual obligation to the GAR holders or to disadvantage others was surely a failure of management and should be treated as such in terms of who pays. In a mutual company, where the policyholders were also the owners, they would bear that charge, but they bore the cost of management failures in any case, as that was a risk of ownership.
An officer from the prudential division asked colleagues and GAD whether any successor company to Equitable would be able to take advantage of their future profits implicit item. FSA had written to a bidder offering some comfort on the matter, but the prudential division needed to be clearer in their own minds what their own view on this was. It was worth doing this now since, while FSA should not seek to be drawn further on this, a fuller response would become critical to the bidder. As a matter of policy, section 68 orders for future profits implicit items were usually granted if the company was able to use them. The officer asked if there were any grounds on which FSA would recommend the Treasury not to grant such an order.
21/11/00
GAD told the prudential division that they agreed that Equitable's future profits implicit item could, in principle, be transferred to a company taking over the business. Another respondent commented that, as far as he was aware, "we" had never refused to grant a section 68 order for a future profits implicit item, although there had been disagreements over the figure.
GAD advised the prudential division on regulatory issues arising from proposals put forward by bidder B as to how they might fund a bid.
The prudential division told the FSA chairman of their discussion with bidder A over the use of inherited estate to finance the purchase of Equitable. The prudential division said that they saw no justifiable basis for such attribution on anything like the scale that would be of interest to the bidder. It was difficult to see how using their with-profits fund to support Equitable could be in the interests of bidder A's own with-profits policyholders.
22/11/00
An internal minute within the prudential division noted that if a successor company had an unlimited ability to scale back the benefits under GAR policies, so that insolvency was always avoided, this could potentially put policyholders in a worse position than if the transfer to the new company did not go ahead.
Equitable's appointed actuary sent the prudential division the estimated solvency position as at the end of October 2000; excess assets had fallen to £1.08bn.
A meeting took place between FSA's prudential division, GAD and a potential bidder to discuss their proposed bid. The bidder expressed concern that the liabilities to GAR policyholders could not be quantified, and said that they were exploring ways in which they might limit their exposure to that liability. They said that their current view of the value of Equitable's business, and the price that they might be prepared to offer, was rather less than they had previously thought. Funding of any acquisition would not now use free estate. It was recognised that certain aspects of the proposals could give rise to concerns from a conduct of business point of view and there were some compliance issues which the bidder had identified; FSA therefore agreed to consider the possibility of a meeting between the bidder and both prudential and conduct of business regulators. The potential bidder was also concerned at the possible implications for them, were they to purchase Equitable, of the continuing enforcement action against Equitable.
The Chairman's Committee met and discussed the matter of guidance that FSA were proposing to issue to the industry following the House of Lords' judgment. It was agreed that Counsel's advice should be sought as to what actions it would be reasonable for FSA to take in that regard, and the risks involved.
23/11/00
GAD replied to Equitable's letter of 16/11/00, questioning the consistency of their approach to GAR reserving with the Government Actuary's 1999 guidance and the method and assumptions used in assessing the GAR liability on future premiums. In particular, they asked for justification of an assumption that premiums on contracts containing GAR options would reduce by 20% annually; the effect on the resilience reserve of a number of modifications in Equitable's method of calculation; and the appropriateness of the ½% charge on accumulating with-profits business. Equitable's actuarial advisers had said that removing the charge would increase Equitable's liabilities by £950m. GAD also asked whether reserves were adequate to provide for the flexibility afforded to policyholders by virtue of the fact that benefits could be taken over a wide range of ages, with the full value of any GAR and with no market value adjustment.
The prudential division received a call from Equitable updating them on progress on the sale. A note of the call said that, while no mention had been made of the price that might be offered, Equitable's managing director appeared to have more realistic expectations than a few weeks previously.
A conduct of business officer e-mailed a colleague (copied to the prudential division), saying that Equitable had settled a complaint by a GAR policyholder by making an immediate payment with a further similar payment to follow in three months time, provided the policyholder did not comment to the press and issued no defamatory information about Equitable. The officer noted that other Equitable issues that FSA's conduct of business division were looking at included: the impact of the GAR ruling; GAR selection of annuity type review; pension fund withdrawal disciplinary action; the response to the PIA visit report of August 2000; and advertising issues relating to Equitable's past performance, and poor present situation.
The director reported to the managing director and the chairman the position on one of the bids. The bidder (A) would put just under £1bn into Equitable, a much lower figure than had at first been thought. The bidder saw the pension fund withdrawal enforcement case as a potential show-stopper because of the likely reputational damage and the cost of any resulting compliance changes required. They were seeking comfort from FSA on two key issues: the structure of Equitable funds post-acquisition and transitional arrangements to preserve the value of the business between a recommendation being made to policyholders and a vote being held, since they were very concerned that the value of Equitable would erode away rapidly between a recommendation being made by the Board and voted on by the members.
24/11/00
Bidder A wrote to FSA's prudential division setting out proposals which they believed would enable them to limit, and therefore to calculate the required level of reserving for, the GAR liability.
The director sent the managing director a memorandum about the options available to Equitable if no sale were to be achieved, which he copied to the chairman and the conduct of business director. He said that Equitable were covering their required minimum margin but there were doubts about their interpretation of guidance and adherence to recommended resilience tests. They could strengthen their reserves by £1bn and still only just meet the required margin. The memo listed the various options open to Equitable to improve their statutory and realistic financial position.
GAD submitted their detailed scrutiny report on Equitable's 1999 regulatory returns giving them a priority rating of 2. They said that although at first sight the solvency position looked reasonable, with available assets of £3.861bn to cover a required minimum margin of £1.114bn, that figure included a future profits implicit item of £925m, disregarded liability to repay a loan of £346m, and benefited from a reduction in liability of almost £1.1bn resulting from the reinsurance agreement. Without those factors, the available assets would reduce to £1.511bn. The report also noted that the aggregate asset share was close to the value of the fund [i.e. there was no estate]; that reliance on the reinsurance agreement was not wholly satisfactory from a regulatory point of view, as it removed over £1bn from Equitable's liabilities but would not be available in the event of insolvency; that the assumption of 85% take-up of GARs was lower than had been specified in guidance note DAA13 (though it was recognised that any take-up in excess of 60% would be met by the reinsurance treaty); that Equitable were exposed to falls in the equity market (a fall in the market of 15% being enough to leave them unable to cover the required minimum margin); and that Equitable would be unable to reinstate the seven months loss of bonus unless funds were made available by a prospective purchaser. It said that the question of whether Equitable should continue to sell non-GAR policies in a common fund with GAR policies could be considered an "environment risk".
FSA's Firms and Markets Committee met. They noted that the sale was becoming increasingly complex and, while two bidders remained, it was far from certain that a sale would take place. The Committee discussed regulatory issues that they felt might arise from proposals that had been put forward by one of the remaining bidders and noted that the prudential division were considering what action would be required if neither bid were successful.In response to the director's report of 23 November on bidder A's bid, the chairman queried whether the Equitable Board would be able to act on one of the bidder's proposals (which, he said, would alienate the Society's assets and appeared to leave policyholders with Hobson's choice) without policyholder approval, and asked for clarification of the FSA's role if Equitable did carry it through.
27/11/00
The prudential division told Equitable that it was likely - though not certain - that eligibility for a section 68 order permitting a future profits implicit item could be transferred to an acquiring company. They said that, as a matter of policy, orders in relation to an implicit item for future profits had generally been granted when relevant requirements were met.
GAD told the prudential division that in their view the proposals contained in bidder A's letter of 24/11/00 would not meet policyholders' reasonable expectations, and would appear even to undermine the concept. They said that, in effect, the proposal relied heavily on things turning out for the best, exactly the philosophy that they said had given rise to complaints about Equitable's current management. It was possible that bidder A had reached the view that Equitable could not be saved and was looking to acquire the sales force and administrative capability at a low price.
In an internal memo, the prudential division reported the outcome of a meeting that they had attended with the enforcement division and Equitable about the sale of pension fund withdrawal contracts. Before the meeting the prudential division had told the conduct of business division of their concerns that regulatory action - and punitive fines in particular - would be detrimental to the interests of policyholders, and that such action could disrupt or even destroy the sales process. They said that the enforcement division had appeared "uncomfortable" with the idea that they should take such factors into account. The enforcement division and Equitable had agreed at the meeting that adjustments would be made to Equitable's procedures in respect of such sales, though they had been unable to agree on the question of whether a review of contracts already sold was necessary. The enforcement division had undertaken to keep the prudential division informed of progress.
The prudential division noted the outcome of a meeting that they and the conduct of business division had attended with bidder A. They said that the meeting had concluded that, in PIA marketing terms, bidder A's proposals were workable, but would require some rule waivers which would have to be approved by the PIA Board. Bidder A were to write to PIA highlighting the issues and PIA would then make a case for the waivers to be put to their Board; the memo said that that would probably fall to the conduct of business division to deal with. The prudential division would probably be asked to make a contribution to that submission, setting out the implications should the bid fail. The one potential show-stopper was if PIA should decline the request for the rule waivers. If that happened the deal lost commercial viability for the bidder.
GAD advised the prudential division in respect of certain aspects of proposals submitted by another potential bidder, bidder C, concerning funding of the bid. They said that they remained unconvinced of bidder C's arguments in support of the proposals, but would need more information if they were to comment further.
28/11/00
The prudential division wrote to bidder C setting out further information that they would need to see before reaching a conclusive view on the proposals.
The prudential division, with GAD, met bidder A (see entry for 30/11/00).
According to the FSA Board minutes, the managing director reported on developments in the Equitable case and agreed to report further to the Board at its next meeting.
The prudential division told GAD and the legal advisers that article 4 of Equitable's constitution seemed to remove from policyholders any current protection there might otherwise have been for them under the Policyholders' Protection Act 1975.
The prudential division set out for members of FSA's Directors' Committee the options open to them concerning the proposal to issue guidance to the industry.
29/11/00
The prudential division wrote to Equitable suggesting a meeting to discuss a number of issues that had arisen during discussions with potential bidders.
Equitable's appointed actuary replied to GAD's letter of 23/11/00. He said that he had explained in his letter of 16/11/00 that his assumption as to the level of take-up of GARs was consistent with the Government Actuary's guidance that the reserves held for GARs should not be reduced by more than 5%. If the guidance had meant that the actual take-up, rather than the effect of that on the reserves, should be no less than 95%, then he would need to reflect that in the 2000 returns. He provided justification for the ½% per annum charge and the assumption of 20% annual reduction in future payments into GAR policies (saying that relevant premium income had declined by 25% per annum over the years 1997 - 1999). He also set out arguments in support of his approach to resilience reserving.
In a memo to FSA's managing director and the chairman, the prudential division said that two bidders - A and C - remained; but for reasons relating to their respective plans for Equitable following acquisition, Equitable saw bidder A as the clear front runner. The prudential division went on to say, however, that bidder A had made clear to them that any bid they might make would be on stringent terms and so might come as an unpleasant surprise to Equitable policyholders. Bidder A were nervous about the potential effect of a number of compliance issues. These included: the enforcement action in respect of pension fund withdrawals; the consequences of a PIA visit in June; the position of pensions sales since the Lords' judgment; and the extent to which the new management might be held responsible for sales made by Equitable after the deal had been announced, but before the scheme had become effective (in practice, the prudential division said, this related to top-up payments on existing policies). Bidder A would decide by the end of the week whether a bid made sense for them in overall economic terms, and would submit a recommendation to their Board on 7/12/00. The memo listed a number of issues which needed addressing, and on which a common understanding with FSA needed to be reached, before the bidders could reach a decision on a bid. The memo was copied to the conduct of business division.
GAD told the prudential division that, if they were to close to new business, Equitable might have to make further cuts in bonus rates, perhaps up to 10%. That might be a significant factor discouraging bids.
The prudential division, with GAD, had a further meeting with bidder A.
30/11/00
The prudential division sought Counsel's advice as to whether it would be appropriate to issue guidance to the industry on the House of Lords' judgment, and on the form that any such guidance should take.
The prudential division circulated an e-mail internally and to GAD (though not to the conduct of business division) suggesting an agenda for a proposed meeting with Equitable to include: Equitable's view of the bidding process and whether they were still confident of securing a deal; what contingency plans they were making; Equitable's response to GAD's letter on reserving (23/11/00); PIA issues; and Equitable's rectification scheme.
In an internal memo the prudential division reported details of the meeting that they had attended on 27/11/00 with the conduct of business division and bidder A to discuss certain aspects of the proposed bid. The memo also noted that a further meeting had taken place on 28/11/00 between bidder A and the prudential division. The meeting had discussed remaining areas of concern to the bidders namely: marketing; the reputational risk associated with any enforcement action (in relation to alleged pensions mis-selling); reserving issues including bidder A's hope that the acquired with-profits business would continue in a separate ring-fenced fund; and the protection that Equitable's articles of association afforded to limit the exposure of the successor company not only to discretionary liabilities but also those provided for under contract [which included top-ups]. The memo said that bidder A and the prudential division had also explored ways to limit bidderA's exposure to discretionary benefits while protecting (on the face of it) contractual guarantees. Bidder A had indicated that that did not provide sufficient protection to their existing policyholders or shareholders and accordingly they would not be able to proceed with an offer on that basis.
The prudential division circulated a paper which set out options for further action on the possible issue of guidance to the industry. That said that, having reviewed their own practices, a number of insurers were taking a similar approach to that now adopted by Equitable, (namely paying the full bonus rates to GAR and non-GAR policyholders) and offering compensation to those already retired.
An internal GAD e-mail expressed doubts about whether Equitable's proposals of 29/11/00 as regards the ½% Zillmer adjustment assumed in the resilience scenario were consistent with the regulations either before or after the 2000 amendments, and so would not be acceptable in the regulatory returns for 2000.
01/12/00
A meeting took place between the prudential division, GAD and Equitable. According to the prudential division's note of the meeting, Equitable confirmed that one of the potential bidders had pulled out two weeks earlier, but remained interested in acquiring the sales force and infrastructure. Another bidder was contemplating a very small offer price, with no goodwill element for policyholders. The other remaining realistic bidder's proposal would involve the immediate sale to them of the sales force and infrastructure and would not allow Equitable an opportunity to consult their members before doing so. It was noted that that gave rise to concerns both for Equitable and FSA; FSA were reported to be considering the implications of the proposal. Equitable's managing director did not know how much bidder A intended to offer, and said that it was possible that the sum would be insufficient to allow Equitable to proceed with a sale. Should that be the case, then it was likely that the company would close to new business and sell the sales force and infrastructure. It was noted that disagreement remained between GAD and Equitable as to the interpretation of the requirement to reserve on the assumption of 95% take-up of GAR options; Equitable's appointed actuary confirmed that actual take-up was below 50%. There had been some discussion about Equitable's use of the ½% Zillmer reduction when calculating the resilience reserve, a practice which the appointed actuary confirmed had been followed since the early 1990s. GAD said that it was not in accordance with the regulations and they had understood, from conversations with the appointed actuary's predecessor, that Equitable would not make such a reduction. The appointed actuary agreed that the assumption of 20% annual reduction in GAR premiums had to be reviewed. Equitable had not considered whether policyholders who had joined after the House of Lords' judgment could be excessively disadvantaged in a closed fund, since from that date it had been known that preferential treatment would be given to GAR policyholders. Equitable's managing director confirmed that the sales force had been adequately briefed and instructed to advise potential policyholders of the company's circumstances. He said that Equitable had taken legal advice as to whether they should continue to write new business.
GAD provided FSA's prudential division with comments on the appointed actuary's letter of 29/11/00. They said that Equitable's assumption of the GAR take-up rate should increase from 85% to 90%; however, that would not lead to an increase in net reserves while the reinsurance treaty remained in place. They also said that they did not accept the use of ½% allowance for expenses, and were not happy with an assumption that the appointed actuary had made of a 20% annual reduction in payments into GAR policies. The use of the new resilience test 2 would increase the resilience reserve by £600m (although that would reduce to £300m if a different concept were used but there would have to be an offset against another reduction in the resilience reserve). They set out a number of other points on which there was at least a possibility that the appointed actuary's calculations would have to be amended, and said that the net result of all such amendments would be to reduce Equitable's solvency margin from £1,080m to £70m. [An arithmetical error in GAD's calculations which was later found by the prudential division meant that £70m should have read £20m.] Were the reinsurance treaty to be terminated, liabilities would increase by approximately a further £1bn (or with the treaty in place £500m at 12/99 given a 60% threshold). [That is, if only 60% of GAR policyholders took up the GAR option or if any liability over 60% was covered by reinsurance.] GAD said that would mean that Equitable would be very close to not covering their required minimum margin.
The prudential division noted in an internal memorandum that conversations with the two remaining potential bidders had suggested that they might both be about to pull out of the process. It might therefore become clear as early as 08/12/00 that no bid would be forthcoming; FSA and Equitable would then need to be ready to respond quickly. A very early announcement by Equitable that they were closing to new business would be preferable. For their part, the prudential division would need to be ready to explain the regulatory implications, and why they had not forced closure immediately after the House of Lords' judgment or possibly even earlier.
FSA's Firms and Markets Committee met and noted that they were to meet the take-over panel to seek advice on one aspect of proposals put forward by one of the remaining potential bidders. They were told that an announcement regarding a bid was expected during the week beginning 18/12/00.
FSA's managing director told the prudential division that the draft guidance to the industry of 30/11/00 was a great improvement although he thought that the recommended option would still get a "pretty rough time". He added that FSA had to accept or challenge companies' returns; they had at some time to make a judgment themselves about the decision each company made.
At a meeting with FSA's prudential and legal divisions, Counsel advised that any guidance that FSA might issue should avoid trying to instruct firms as to how they should interpret the House of Lords' judgment. Counsel advised telling firms that it was their responsibility to consider what implications the judgment might have for their own particular circumstances, and offering general guidance only on the matters that such consideration should take into account, including the need to take legal and actuarial advice.
04/12/00
GAD wrote to Equitable's appointed actuary following up a number of points raised at the meeting of 01/12/00. They disputed Equitable's assumption of 85% take-up rate of GARs, arguing that in Equitable's particular circumstances it would not be prudent to assume a take-up rate lower than 90%; they pointed out that the actuarial advisors had assumed a 10% reduction in future payments into GAR policies (as opposed to Equitable's assumption of 20%), and said that they would therefore be looking for a stronger assumption in that respect at the year end; and they added that the use of the ½% charge was causing them particular concern and would not be acceptable in the returns as at 31/12/00. They also asked for further clarification on certain aspects of the actuary's approach to resilience reserving.
Bidder C notified FSA's prudential division that they had decided to pull out. They said that through the due diligence process they had identified material risks for their own shareholders were they to proceed on the basis that they had proposed; unusually that risk could not be factored into the purchase price since a lower price simply increased the risks. They had considered a different approach to acquisition, by which they believed that it might be possible to restore Equitable to a viable business by converting it to a unit-linked business. If that option were to be pursued, however, they would want a period of exclusive negotiation, to which Equitable had been unable to agree. Bidder C had indicated that they might be interested in reopening discussions were Equitable to agree to their terms.
In an internal memo FSA's prudential division reported a conversation with the remaining bidder, bidder A, who said that they were becoming increasingly concerned that acquisition of Equitable would be uneconomic. They said that the price that they might be prepared to pay could be significantly lower than had previously been discussed, and might be at such a level as to be unattractive to Equitable's members. Any goodwill associated with a sale might then be lost. They said that the bid was to be considered by their Board on 07/12/00 and that it was not possible to predict the Board's decision. While it was recognised that bidder A might simply be attempting to pave the way for a substantially reduced offer, the memo suggested that their comments be taken at face value, since they echoed what others had said. The memo also suggested, however, that FSA continue with the preparations and analysis already in hand, so as to be ready to respond quickly should the sale go ahead.
A letter from FSA's enforcement division to Equitable, which was not copied to FSA colleagues, said that PIA required Equitable to meet their concerns and suspend sales of pension fund withdrawal products until they could demonstrate compliance with PIA rules, amend the process for new business in that area, and provide a project plan for a review by Equitable of its past business. A reply by 15/12/00 was required.
In another internal FSA memo, the relevant director noted that if an offer were made for Equitable, FSA would have considerable difficulty making a decision on it as quickly as the buyer would wish as the issues for them were complex and, at least presentationally, extremely awkward. They needed to start preparations, however, in case they needed to use their formal intervention powers, and he asked for a paper outlining the possible outcomes of the bidding process and the relevant issues to be addressed as a result of each.
05/12/00
The prudential division sent the FSA managing director a briefing note, in preparation for a meeting he was to attend with Equitable's chairman and managing director, in which they said that Equitable had free assets of £70m above the required minimum margin - a margin that was uncomfortably tight. [Due to a typing error, the original note said £7m but the file copy seen by OPCA had been corrected in manuscript to £70m (see second entry of 01/12/00). In fact GAD had made an arithmetical error in that calculation and the net outcome of the various possible adjustments they had considered on 01/12/00 should have been a figure of £20m.] The prudential division said that was £1,010m [correctly £1,060m] less than Equitable's own estimate (as at end October), the difference being attributable to possible adjustments that GAD had considered to various assumptions in the reserving basis that had been raised by the auditors to bring the assumptions into line with what GAD would normally expect. The prudential division believed that if no bid were forthcoming, they would have grounds for closing Equitable to new business, either for failing to meet the required minimum margin or because of the risk that policyholders' reasonable expectations would not be met, but they would prefer Equitable's directors to take that decision.
FSA's managing director proposed an urgent meeting of the Tripartite Standing Committee (paragraph 37) to consider the possible impact of the worst foreseeable outcome (closure of Equitable to new business) and the steps to be taken as a result.
In an internal memo FSA's prudential division said that they had received legal advice to the effect that they had no powers to prevent Equitable from accepting top-up payments to GAR policies.In a briefing note for the Tripartite Standing Committee, copied to the Treasury, the prudential division said that only three of the 15 companies who had expressed an interest had shown a serious interest in taking over Equitable. All had considered it not to be a viable prospect. Equitable were only just meeting their minimum capital requirement; although they had around £2bn in their Companies Act accounts, that would be exhausted were equity markets to fall by around 20-25%. The prudential division said that Equitable would have no choice but to close to new business, although they would continue to operate as a closed fund [that is, to service only existing policies]. While a number of closed funds had been acquired by third parties, who had then provided capital support, that had not proved to be a feasible option for Equitable. Allowing Equitable to accept further premiums on GAR products [i.e. to make top-ups] would disadvantage other policyholders. While guaranteed benefits would continue to be met in full, there were likely to be cuts in bonus rates over the next few years.
The Chairman's Committee considered the implications, both for Equitable and for the industry as a whole, if the one remaining bidder withdrew, which seemed increasingly likely. If that happened, Equitable would have to close for new business, but FSA thought it preferable that they did so voluntarily. It was agreed, however, that FSA now needed to plan on the assumption that the final bidder would pull out, and that Equitable would then need to make a quick decision about closure. If Equitable did not volunteer to close to new business, then FSA would need to consider their financial viability. It was considered that FSA had the powers to close the company under section 45 of the 1982 Act (paragraph 34). The Committee agreed that that would address the initial situation, but that it would also be important to resolve the issue of whether there was any scope for FSA to prevent policyholders with GARs from topping up their policies. The Committee also considered the advice that had been obtained from Counsel on the proposed guidance following the meeting of 29/11/00.
The head of prudential supervision told the managing director and prudential division colleagues that GAD had clarified how thin and fragile Equitable's margin was. If there was no prospect of a sale Equitable would be told that FSA could not allow them to continue to trade, although they might consider allowing a period of grace for a few weeks to allow them to effect a fire sale of bits of the business.
06/12/00
FSA's senior legal officer commissioned some work so that FSA would be in a position, if need be, to be able properly to exercise their formal intervention powers against Equitable later that week. The first possible ground he saw for doing this was that Equitable were unable to meet their liabilities to policyholders; this was problematic as (in his view) their article 4 limited their liability to policyholders to the amount of their assets. [This view was not shared by the Treasury.] The second ground related to the interests of policyholders and potential policyholders; FSA would need a view on whether the action proposed was a proportionate way to protect the interests of those policyholders. The third ground was sound and prudent management which, he said, must be exercisable. Finally FSA might act on the ground that Equitable might be unable to fulfil the reasonable expectations of long term business policyholders; this seemed highly likely to be exercisable.
A meeting took place between the prudential division, GAD, and Equitable. Equitable were aware that the one remaining bidder was unlikely to make an offer; the bidder would make a formal decision at a board meeting on 07/12/00. Equitable said that if no bid emerged, they would close the with-profits fund and very likely the unit-linked business too. The prudential division explained that they would have a problem in allowing them to continue to write unit-linked business because it appeared that those funds could then be used to meet Equitable's wider liabilities; Equitable accordingly agreed that if no bid were forthcoming they would close to all new business.
The Tripartite Standing Committee met. Equitable's position and the impact of their closure on other companies were discussed. It was agreed that Equitable's position was unique and there should not be significant industry repercussions. While there was no systemic threat, three important stakeholders were Equitable's staff, their policyholders and the markets. Policyholders should be encouraged not to rush into decisions. It was noted that Equitable could not refuse top-up payments from with-profits holders with GARs, even though they would potentially harm non-GAR with-profits policyholders. FSA said that that was why, given Equitable's lack of substantial surpluses, if no sale was likely they could no longer prudently write new business. If Equitable had not reached that conclusion themselves, FSA would have been looking to step in and prevent them taking new business. As to why earlier action had not been taken, FSA would explain that there had until then been a reasonable expectation of a sale, which closure to new business would have destroyed. [In what the Treasury say is the initial detailed draft note of the meeting, the Treasury asked if "we" should have stopped Equitable putting out so many advertisements recently. FSA said that, following a FSA phone call about a month earlier, the advertisements had been scaled down, but that might also have been a response to adverse press comment. That exchange did not appear in what the Treasury say is the final version of the meeting note.]
Treasury officials briefed the then Economic Secretary that the last remaining bidder for Equitable was likely the next day to decide against bidding and Equitable would then close to new business, possibly causing a ripple in the gilts market and leaving 650,000 policyholders looking for advice. The main reason that a sale had not taken place was said to be that it was impossible to cap Equitable's GAR liabilities. Equitable were only just meeting their capital requirements, so there was little working capital available to underpin the writing of new business. FSA estimated that the impact of the Lords' judgment would be to reduce returns to policyholders by 10%; however, such returns would still compare well with those of many of Equitable's competitors. While it might be argued that the regulator should have stopped Equitable writing new business sooner, there had until a few days previously been every sign that a sale could be achieved. The regulators had been just as surprised as the markets that no buyer could be found. The briefing said: "Does this event show up a deep seated oversight on the part of the regulator? Probably." [in failing to ensure that proper risk management processes were in place at Equitable] but the briefing added that the oversight was not life threatening until the Lords' judgment, the scope of which had been quite unexpected.
FSA's Directors' Committee met to discuss the advice that had been obtained from Counsel on the guidance that it was proposed to issue in respect of the House of Lords' judgment. The Committee agreed to amend the draft guidance in line with Counsel's advice and submit it to the Board.
07/12/00
Bidder A withdrew from the bidding process.
08/12/00
Equitable closed to new business.
FSA's Firms and Markets Committee met. They considered that the circumstances which had led to the closure of Equitable to new business were largely unique to the company. The company would now "go into solvent run-off" and there would be a need to calm any panic reaction by policyholders. The minutes of the meeting said "It was queried whether proper disclosure about the firm's position had been made since the House of Lords' judgment. It was suggested that, if it had not, policyholders might be able to claim compensation for mis-selling. There might also be a need to consider disciplinary action." It was noted that the pension fund withdrawal disciplinary case was still on-going and could cost Equitable a further £30m.13/12/00
The eighth quarterly meeting took place between the Treasury and FSA's prudential division. According to the Treasury's note of the meeting, they asked whether there would be a FSA internal enquiry into Equitable. The prudential division said that a paper was being prepared to put before FSA's Board on options available to the company, and whether there were any lessons to be learned, but that any decision making that might have contributed to Equitable's problems would have been the responsibility of DTI. The director explained that there had been three heavyweight bidders at the outset with bidder A the most realistic and likely option. However, ring-fencing the GAR liability by buying out the options would have cost bidder A over £1bn and they could not afford to do this in addition to the launch of stakeholder funding. He said that neither FSA nor Equitable had realised the extent of the GAR liability which was usually dealt with by varying the terminal bonus. The GAR liability was thought to have been capped. FSA had not appreciated the scale of the problem; they said that it had been a "wake-up call" for them and for the industry to review their structure and their strategies. Regarding allegations that had been made of mis-selling after the House of Lords' judgment, the prudential division said that, although a script provided to Equitable's sales force by the company had not dealt with the problems, it would have been unreasonable to stop the company from continuing as a going concern while a sale was anticipated. The Treasury questioned the role of Equitable's appointed actuary. As for Equitable's auditors, the prudential division were reported as saying that the Lords' judgment had been completely unexpected and that the management of the company would have been more culpable. They suggested that any action taken against the auditors would probably have a realistic chance of success only in respect of the period after the House of Lords' judgment, in which case liability would be small and easily managed.
15/12/00
The FSA Board noted a paper by the managing director saying that FSA judged the main reason for the last three potential bidders for Equitable dropping out to be that, as the bidders went through the due diligence process, they had concluded that:
- GAR policyholders could put in very large amounts of extra money that would also benefit from the guarantees; the stronger the acquirer the greater the incentive to put in more money. This together with uncertainty on future interest rates made it difficult to estimate the eventual liability.
- All existing policyholders seemed to be expecting a large payment for the sale of the Society. Interested buyers were thus faced with the choice of either paying far more than they thought Equitable was worth or paying less for "goodwill" and finding that there was "bad will".
The managing director said that while Equitable were still meeting their solvency requirements the decision to stop new business had been taken because they lacked the resources to underwrite new business convincingly. FSA had been prepared to intervene but Equitable had already decided to close to new business so no use of FSA powers had been necessary. So far as the actions of FSA were concerned, he said that it was worth noting that by end 1998 FSA were requiring reserves in the statutory accounts that the whole industry felt were excessive. He also commented, in respect of the "accusation" that FSA should have made Equitable explain the implications to potential new members (some 15,000 policies had been sold between the Lords' judgment and early December) and/or limited its advertising, that this raised some important issues. Equitable were obliged to ensure that their sales did not involve misleading representations; if they did this was grounds for a claim for redress. On that basis, hitherto, FSA had generally been reactive in monitoring advertising.
19/12/00
A bilateral meeting took place between FSA's prudential and conduct of business regulatory divisions. This was the first such meeting since August; there was no meeting in October. The current position and future action were discussed.
2001
05/02/01
Equitable announced the sale of their operating business to the then Halifax Group plc who paid £500m, with the prospect of a further sum of up to £500m to follow. Half of the latter sum was conditional on Equitable's policyholders agreeing to cap the GAR liabilities - which they subsequently did - and the remainder on the salesforce meeting certain performance targets.
31/08/01
The then Economic Secretary announced the setting up of the Penrose Inquiry.
17/10/01
Baird report published to Parliament.
