Case No. C.1597/01para 168 - 238
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Part II: C.1597/01
Introduction | |
Background to the complaint | |
| Chapters 104 - 167 | Further evidence & developments |
Chapters 168- 238 | Chronology & conclusion |
Chronology & conclusion
Period from 1 January 1999 to the Court of Appeal judgment (January 2000)
Regulatory solvency
168. There is no doubt that in late 1998 the Treasury had briefed FSA in considerable detail about Equitable's weak regulatory solvency position and had indicated a possible need for the regulator to intervene if Equitable either: a) continued to refuse to accept the need to reserve to the level GAD thought appropriate to cover the GAR liabilities, or b) declared a bonus without the regulator's prior agreement. However, that position stood to be resolved, at least to an extent sufficient to satisfy FSA's requirements in relation to reserving, by the reinsurance agreement Equitable were in the process of negotiating. By 1 January 1999, when the FSA took over as prudential regulator, the situation had therefore moved on sufficiently for the Treasury's earlier indications of a possible need for immediate intervention to be regarded as no longer valid.
169. Nonetheless, it was certainly not true to say that FSA knew that Equitable's position needed to be closely monitored and did nothing. On the contrary, it is very evident from the activities described in detail in the chronology that, whatever view one might take of the prudential regulators' stated approach to their role (as described in paragraph 35), they could not be criticised for a lack of concern about Equitable and the position of their policyholders nor could their approach in respect of Equitable be described as 'passive'.
170. It is clear that a great deal of thought and discussion went into the situation and that FSA's prudential division, with GAD's support, made continued efforts to try to ensure that Equitable took appropriate action to secure adequate reserves and that Equitable did not take steps which would have worsened their solvency position. This was demonstrated by FSA maintaining their stance on the need for Equitable to conform to the reserving requirements in the face of Equitable's strong resistance, (Equitable had submitted Counsel's opinion that the prudential regulator's approach to reserving was unreasonable; and had also threatened judicial review if FSA continued with that approach); FSA continuing to urge Equitable to be cautious about the bonuses they paid (warning them that they would use their powers to intervene if Equitable attempted to declare a bonus before FSA were satisfied that they had sufficient reserves in place); and their requiring submission, some three months ahead of schedule, of Equitable's 1998 regulatory returns, which were then subject to early detailed scrutiny. I note that the latter action was specifically required because of FSA's concern that the 1997 regulatory returns might have given policyholders and potential policyholders a misleading impression of Equitable's financial position (see paragraph 63). This was seen as the only way forward as the Treasury had previously received legal advice (see paragraph 55) suggesting that they had insufficient grounds to take action against Equitable for not previously having included the GAR liabilities in their regulatory returns, and (see Appendix C, 11 December 1998) that they had no powers to require Equitable to reissue or amend the 1997 returns.
171. FSA (with GAD) cannot therefore be said to have addressed the GAR reserving issue - and the linked possible misrepresentation of the strength of Equitable's financial position - in anything less than a resolute manner. But that still leaves the question of whether, having seen Equitable's position as so serious that regulatory intervention might be required, it was appropriate for the FSA to allow Equitable to rely to the extent that they did on reinsurance and on the future profits implicit item effectively to balance their books. Should these have been regarded largely as 'window dressing' as they did not improve Equitable's underlying financial position, but were mainly technical ways of enabling Equitable to satisfy the statutory regulatory requirements without actually increasing their reserves? Even more significantly, Equitable then used them not only to balance the books, but as grounds for their being able to declare a bonus of 5% for 1998 (when they were contractually bound to pay 3½% only to the guaranteed interest rate policyholders - who were in the majority). I examine these two matters in turn.
Reinsurance
172. FSA (on GAD's advice) did not discourage Equitable from considering reinsurance, as it was within the rules. As I understand it, reinsurance was an accepted way of meeting the regulatory solvency requirements, and not unusual in the insurance industry. I can understand why, with the benefit of hindsight, GAD later took the view that Equitable had probably not been wise to rely on it to the extent that they did. Given that the agreement stood only for as long as the differential terminal bonus scheme remained unchanged, and would otherwise fall to be renegotiated (see paragraph 66), it meant that, if Equitable lost their court case (a factor outside Equitable's control), they would be left in a considerably weakened negotiating position. Nevertheless, as reinsurance was an accounting practice which was accepted as legitimate by the profession and the industry, and was backed by FSA's own professional advisers, I do not see how FSA could reasonably have refused to accept its use in Equitable's case.
173. I would add in this respect that I note that FSA, with GAD's guidance, did not simply accept Equitable's word that the reinsurance agreement did what it was supposed to do. They took an active interest in the terms of the agreement and suggested to Equitable a number of amendments to the terms to make the agreement as robust as possible and, most importantly, to ensure that it was subordinate to policyholders' interests. I considered whether the condition attached to the agreement (that it only stood as long as the differential terminal bonus policy remained unchanged) should have led FSA to question whether they should accept the reinsurance as valid for solvency purposes. The expert advice I received was that the condition could be seen as a general and (given the nature of the agreement) properly prudent provision, backed up by an understanding as to how certain possible outcomes of the litigation might be handled. It did not render the reinsurance agreement worthless if the policy changed, it simply meant that the agreement fell to be renegotiated. In the event, following the House of Lords' judgment, Equitable were able quickly to renegotiate a revised agreement. I am therefore satisfied that FSA's acceptance of the reinsurance agreement was not maladministrative.
174. I note that the agreement was not signed until 30 September 1999 by the reinsurer and 11 October 1999 by Equitable, some considerable time after it had first featured and been relied upon in the regulatory accounts. Although that meant that the agreement was only signed some time after it was deemed to take effect, I understand that that was of no consequence. The expert advice I have received supports the evidence given by FSA staff that a delay of this kind was not uncommon, and that the reinsurer was effectively on risk once the terms had been agreed. That meant that the reinsurer, if called upon, could not have refused to honour the agreement on the grounds that it was unsigned.
Future profits implicit item
175. I note that Equitable made applications for future profits implicit items for £500m in 1994, £850m in June 1998, £1.9bn in December 1998, and then £1bn in March 1999. Were FSA right to allow Equitable to rely so significantly on future profits implicit items in this way? When considering this matter, it is I think important to bear in mind that this was not simply a concession made to Equitable. It was a concession available to all [life] companies under the 1982 Act and Equitable were by no means the only company to take advantage of it (see paragraph 25). Further, the 1994 Regulations set out specifically how the item was to be calculated.
176. According to GAD (see paragraph 124) the increase in the level requested was proportionate to the increasing size of the fund and correspondingly increasing profits (that is it reflected proportionately the growth in Equitable's new business). It did not therefore necessarily indicate an underlying weakness in Equitable's balance sheet, although companies did not like to use future profits implicit items unless absolutely necessary as they thought they would be perceived as a sign of weakness by financial analysts. (This was confirmed by my own actuarial advice.) Further, the large increase from 1998 onwards was specifically to meet the additional GAR reserving requirement FSA had required Equitable to make.
177. I note also officer F's comments that Equitable had been relying on future profits implicit items since 1994, and his explanation as to why such concessions were particularly attractive to mutual companies. The applications were accordingly neither something new, nor could they be described as unexpected. I see also that the sums applied for, although large and increasing, were never fully used by Equitable in their regulatory returns (they used only £850m of the £1.9bn applied for in December 1998) and were still well within what Equitable could have legitimately applied for under the regulations. Indeed as officer J pointed out (see paragraph 145), the largest future profits implicit item sought by Equitable was much lower than the sum for which they had been entitled to apply. That being the case, it is difficult to see on what grounds FSA could reasonably have refused Equitable's applications. Indeed had they done so, it seems possible that Equitable could have had strong grounds for complaint (and possibly judicial review action) on the basis that they were being singled out unfairly for action which would almost inevitably drive them close to regulatory insolvency.
Differential terminal bonus policy and policyholders' reasonable expectations
178. It could, perhaps, be argued that the main point at issue here was the guidance issued by Treasury on 18 December 1998, which appeared to legitimise, albeit indirectly, Equitable's approach to differential terminal bonuses. Did that give false comfort, particularly to Equitable, and thereby add to the false view of the strength of Equitable's financial position?
179. I can see how on the surface - and with the benefit of hindsight - the guidance might be viewed in that way. But it also has to be remembered that the guidance was issued before Equitable started their court action, so it was clearly not the case that they simply relied on it as justification. It was also issued before FSA took on the role of prudential regulator. That said, it is clear that it reflected FSA's own view that there were legitimate arguments in support of the differential terminal bonus practice in certain circumstances. Was that so misguided a view that it might be considered to be maladministrative? Certainly the then Economic Secretary's initial personal response (19 November 1998) to the proposed guidance was that the practice Equitable were operating did not fit in with her own view of what GAR policyholders might reasonably expect.
180. Nevertheless, I believe it has to be recognised that the guidance also reflected general thinking in wider actuarial circles, and that the Faculty and Institute of Actuaries supported it (see Appendix C, March 1999). I note also that Equitable were by no means the only company adopting that practice. That said, although not unique, Equitable were extremely unusual in terms of the size of the company, the proportion of their business affected and therefore the level of their exposure if the practice was judged to be unacceptable. The key point, however, is that the guidance made absolutely clear that the legitimacy of the practice in respect of each company would depend wholly on whether the company had communicated their policy clearly to policyholders. FSA took the view that, if the company had done so, then there could be no question of policyholders' reasonable expectations not being met. That does not seem to me in itself to be an unreasonable approach to take, and certainly not maladministrative.
181. I note, however, that what that guidance did highlight was a weakness in the then current regulatory framework, in terms of the possible drawbacks arising from the lack of a co-ordinated approach by the prudential and conduct of business regulators. Some of FSA's conduct of business staff clearly felt that the guidance could be seen as unfortunate from their viewpoint (see Appendix C, 18 January 1999) and that it served to underline how the two regulators might take a different view on certain issues, in this case on policyholders' reasonable expectations. However, any potential difference in views on what might constitute policyholders' reasonable expectations in relation to Equitable's differential terminal bonus policy had been rendered largely academic once Equitable had decided to take the matter to the courts (see Appendix C, the letter of 18 December 1998 to the Treasury). FSA's prudential division consequently decided that there was little point in them putting significant further effort into trying to reach a firm view on policyholders' reasonable expectations in this regard, as the court's judgment would properly be expected to influence that view. Given the potential significance of the anticipated court ruling to the question of policyholders' reasonable expectations, the decision to await the court ruling was, in my view, reasonable.
182. That did not, however, mean that FSA's prudential regulation division did not continue to explore other issues relating to policyholders' reasonable expectations. For example, they called for Equitable's bonus recommendations and notices to be sent in for review, and shared those with conduct of business colleagues to get their expert view. Early submission of the 1998 regulatory returns meant that the detailed scrutiny was able to be completed well ahead (some ten months) of the normal schedule (see paragraph 19). That in turn meant that FSA's prudential division were then much better placed than they would otherwise have been to assess the strength of Equitable's stance in the various ongoing debates they were having over matters such as the reserving requirements, and would put them in a position to react quickly to reassess whether Equitable were able to meet policyholders' reasonable expectations if the courts either referred the matter back to them or gave a view on the matter.
183. The concept of policyholders' reasonable expectations was not defined in statute at the time and was not at all straightforward. I note the various descriptions of it put forward by officers (see paragraphs 118, 126, 134 and 141), including the view of officer F that it was "nebulous", and of officer H, that it was a matter of "recognising it when you saw it". It is, perhaps, unfortunate that the legislation was not clearer from the outset as to how the concept should be interpreted (in that respect, I note that the term does not reappear in the legislation relating to the current regulatory framework). The key difficulty with the concept was, as officer F indicated (see paragraph 126), that it gave no indication as to how companies were to balance the differing expectations of different groups of policyholders, for example GAR and non-GAR, existing and potential, particularly when action taken to meet one group's expectations would impact adversely on others' expectations. That judgment was rendered all the more difficult in Equitable's case because of their lack of significant free estate or shareholders. The company could not therefore use their reserves or call for an injection of cash to mitigate such adverse effects. That said, FSA's decision to await the outcome of the court case was not an entirely risk free strategy, because in the meantime, policyholders' reasonable expectations would be being further influenced by then current events and by the way that Equitable were presenting those events to existing and potential policyholders. On balance, however, in all the circumstances, and given the other even more fundamental discussions ongoing between Equitable and FSA about reserving levels for the purposes of regulatory solvency (which would also ultimately impact on whether Equitable could meet their policyholders' reasonable expectations), the decision on FSA's part not to rush to a view until they had the courts' final judgment on the matter was not in my view unreasonable.
Did FSA miss any significant factors?
184. FSA's prudential division carried out scenario planning on the possible outcomes of the court case (see Appendix C, 9 June 1999) and they also considered Equitable's own scenario planning (see Appendix C, 21 June 1999). I note the views of officer H (see paragraph 138) and the relevant managing director (see paragraph 155) that the prudential regulator's role in this respect was essentially to prepare for the various outcomes by identifying any action which might be required of Equitable and of the regulator in each scenario, and to ensure that Equitable carried out similar preparations.
185. One factor that FSA did not specifically identify in that planning was that, if Equitable lost their case, their GAR liability could increase even further - possibly significantly - because of the potential for top-up payments (that is the fact that many existing GAR policyholders were able to make additional premium payments which would also attract GARs). I note that, when asked to assess that potential liability, Equitable had previously told the Treasury (see Appendix C, 11 November 1998) that they were unable to assess the likely impact of such future premiums without scanning all of the files at the year end to determine where entitlement to pay further premiums existed. The papers do not show why FSA's prudential division did not follow up on that point with Equitable, although I note that GAD's discussion with Equitable on 29 January 1999 had revealed that Equitable had, in any event, included an allowance of £450m for future top-ups in their reserving calculation. The issue did not resurface again until Equitable raised it themselves in a paper to their Board (they sent a copy of the relevant Board paper to FSA on 20 April 1999) which discussed possible ways of limiting the growth in GAR business within the overall context of measures open to the company to protect their regulatory solvency position. FSA did not pick up on this at the time, either as a then current reserving issue or as a potential future problem, despite a clear signal in Equitable's comments that they could not see any way in which they could prevent top-up payments, nor could they assess with any degree of accuracy the potential scale of the problem. It could perhaps be argued that FSA should have pressed Equitable to do more work on this issue in this period and on possible ways of resolving it. That said, I recognise that FSA were already devoting a significant amount of time to issues relating to Equitable, and were encountering significant resistance from them to reserving in full for the liabilities which they could far more easily assess. I can therefore understand why that further issue (which, once the reinsurance was in place offsetting any increased reserving liability, would be relevant only if Equitable lost the court case and decided to seek a buyer) was not seen as a priority at that time.
186. Another issue which surfaced during this period (from 1 January 1999 to January 2000) was the role of the conduct of business regulator in relation to the continuing information provided to policyholders after the sales process had been completed. As I have already indicated, the prudential division raised the matter with their conduct of business colleagues in connection with bonus notices, which they considered might have given policyholders unrealistically high expectations of the terminal bonus pay-outs they could expect. Subsequent exchanges between the prudential and conduct of business regulators indicated that, while the prudential division clearly believed the content of post-sales information to individual policyholders to be a matter for their conduct of business colleagues (see Appendix C, 24 June 1999), the latter for their part did not consider that such matters "fitted comfortably within their remit" and said that they would therefore have to have serious concerns about a document before taking action (see Appendix C, 20 and 23 September 1999). That suggested a potential gap in the regulatory framework, and it might be argued that (given the importance of the issue in question, not least for policyholders and their reasonable expectations), both the prudential and conduct of business regulators could have done more to clarify their respective responsibilities. In the event, at this point the prudential division appear to have accepted conduct of business colleagues' view that, from a PIA perspective, the notices were not misleading, and taken that as a sign that no further action was necessary. I do not consider that that was a wholly unreasonable decision in itself for the prudential regulator to have reached, given the advice they had received. Nevertheless, as a result of the matter not being formally clarified between the regulators at that point, the issue remained somewhat unclear and was to resurface again several months later.
Overall, was there anything further that the prudential regulator should have done in this period (January 1999 to January 2000) which would have provided greater protection for Equitable's existing and potential policyholders?
187. I do not consider that there was for a number of reasons. First, although there was no doubt that Equitable were financially weak, that was not something new or surprising. It was a direct consequence of the way that they had always conducted their business, paying out as much as possible in annual bonuses to policyholders and not carrying excessive reserves. That automatically meant that they were inherently weaker than most life companies. Equitable had never made any secret of this, indeed it had been a major part of their sales strategy. An inescapable consequence of that policy, which they also publicised widely, was that Equitable's policyholders would follow the fortunes of the company.
188. It was also clear from Equitable's published material that they were particularly sensitive to changes in market conditions, again because of their lack of substantial free estate and lack of a means to raise quick cash injections (from shareholders). That vulnerability had led to the internal priority rating which GAD had given them varying from year to year (see paragraph 122). It was certainly true that the combination of lower interest rates and changed mortality assumptions had raised the stakes sharply for Equitable, leaving them more exposed than during earlier equity market falls. However, providing their differential terminal bonus policy was legitimate, and it has to be remembered that the High Court ruled during this period (on 9 September 1999) that Equitable were entitled to operate that policy, the professional advice from GAD was that it was still possible for them to manage the situation and work themselves out of their regulatory solvency margin problems. In the light of that, it is difficult to see how FSA could reasonably have argued that that continuing weak financial position, arising from the very practices which had been at the heart of the company's highly successful marketing strategy throughout their existence, had suddenly become grounds for the prudential regulator to consider closure of the company to new business.
189. Most important of all, Equitable remained technically solvent. At no time did they breach the required minimum margin, and they were able to meet the required resilience tests in their regulatory returns. It is important to remember that solvency in the regulatory sense is not at all the same as Companies Act solvency. As has been explained (see paragraph 22), regulatory solvency is set at a much higher hurdle than what is commonly understood as solvency ("several cushions above it", as officer D described it - see paragraph 120) and is essentially a trigger point to alert the company and regulator to the fact that the financial position is becoming critical and that an action plan is required to restore the company to a sound financial position. FSA took the view that, as Equitable had not breached the regulatory solvency requirements as set out in the statutory framework, they had no grounds for formal intervention on solvency grounds.
190. Another possible ground for intervention at that point would have been if FSA believed that Equitable were unable to meet their policyholders' reasonable expectations. Although it is clear that the prudential regulator considered that there was a question mark over whether these were in fact being met (because of the differential terminal bonus policy), they were unable to reach a conclusive view of the matter until the court ad given a final ruling. It would have been premature for FSA to have intervened on those grounds at that stage. Had they done so, and had the court taken a different view, FSA would undoubtedly have been held responsible for making the position of the Society and their policyholders significantly worse.
191. FSA were nevertheless concerned to ensure that Equitable's financial position was not misrepresented to potential policyholders, which is why they pressed them so hard on the reserving issue, and why (having discovered that there was nothing they could do about the potentially misleading mpression given in the 1997 returns) they called for early submission of the 1998 returns. Those gave a much more realistic view of Equitable's weakened financial position.
192. The use by a regulator of their powers of intervention is a discretionary decision. Under section 12(3) of the 1967 Act (see paragraph 5) I cannot question such a decision unless I have seen evidence that it has been reached with maladministration (either that the process by which it was reached was faulty or that the judgment reached was outside the bounds of reasonable discretion). I have seen no evidence that that was the case here. FSA were monitoring Equitable's solvency position and clearly thought through what the likely impact of any potential regulatory action would be on Equitable's policyholders. They reached the conclusion that formal intervention during this period would be disproportionate (and was likely to be challenged in the courts), and that it was in the policyholders' best interests for the FSA to work with Equitable with the aim of strengthening their solvency position to ensure that they could meet their policyholders' reasonable expectations, and to present their financial position as accurately as possible. I do not consider that to have been an unreasonable course of action for FSA to have chosen.
Period from the Court of Appeal judgment (21 January 2000) to the House of Lords' judgment (20 July 2000)
193. Should the fact that two of the three Court of Appeal judges ruled against Equitable have set alarm bells ringing at FSA and have prompted them into some form of intervention? I do not see that that necessarily follows. The High Court had, of course, ruled in Equitable's favour and had been supported by the prevailing view of the actuarial profession at the time that awarding differential terminal bonuses could be an acceptable practice - albeit it was not a common one. Further, as FSA's legal advisers pointed out (see Appendix C, 31 January 2000), each of the four judges who had up to then considered the case had arrived at their varied conclusions for different reasons.
194. Nevertheless the Court of Appeal ruling undoubtedly changed the landscape in that it underlined the fact that the issue was not as clear-cut as Equitable had presented it. It also brought to the fore the issue of ring-fencing, when one of the judges commented that in his view ring-fencing could be legitimate, which would significantly limit the impact of an adverse ruling on Equitable's position. However, given that it was common insurance practice to treat the various types of policyholders differently (for example, insurers generally declared bonuses by class of policy and in line with the characteristics of different policies), I can understand why FSA considered it unlikely that the courts would rule otherwise (see Appendix C, 2 March 2000).
195. That said, I note that the judgment did not prompt FSA to consider in any real depth the potential ramifications (not just for Equitable but for the life industry as a whole) if ring-fencing were not permissible, until it became clear through the House of Lords' hearing transcripts that that was a possibility. I note also that FSA did not revisit their possible outcome scenarios after their preliminary assessment on 28 January 2000 until a few days before the House of Lords' judgment was due to be announced, despite a director on the Equitable Board telling the managing director of FSA on 4 July 2000 that there were "straws in the wind" that Equitable might lose in the House of Lords and that they were considering the consequences of that for the Board of Equitable. Had FSA done so, they would have had more time to consider the potential consequences in greater depth; I cannot, however, see that that would have had any impact on subsequent events.
196. I note also that the prudential division did not draw to the attention of either Equitable or of their conduct of business colleagues their concerns about Equitable's letter of 1 February 2000 to policyholders. I accept that it is difficult to envisage that Equitable would have been persuaded to have done anything about it after the event. I also recognise the strength of officer J's comments (see paragraph 143) that the letter had been worded very carefully in such a way that, while it could be argued that the tone of the letter had gone too far in reassuring policyholders, the words used were not so misleading as to give the prudential regulator grounds to intervene. I note further his view that action by the prudential regulator to require withdrawal or correction might in any event have been de-stabilising for Equitable, as policyholders might have read too much into such action, and that such action would therefore have been disproportionate. It could be argued that, if FSA had taken up the matter as a policyholders' reasonable expectations issue and reminded Equitable of their responsibilities in that regard, then that might have influenced Equitable to think more carefully about what they said to policyholders in the future. However, that can only be a matter for speculation, and given Equitable's robust responses to the prudential regulator on other issues, it seems to me unlikely that such action would have altered the course of events. The prudential regulator's decision as to whether or not to draw to the attention of Equitable their concerns about Equitable's letter of 1 February 2000 to policyholders was fundamentally a matter of judgment. I do not consider that the FSA's judgment in this respect was wholly unreasonable.
197. As for the prudential regulator's decision not to share the letter with their conduct of business colleagues, I note that the latter had in fact received a copy of the letter via another route and had decided independently that no action was required on it. The conduct of business regulators are not within my jurisdiction and it is not therefore open to me to comment on their actions or inaction. I simply note, therefore, at this point officer J's comments (see paragraph 143) that it had not been clear that the letter was a PIA issue since it was not part of the sales process, although it was intended to inform policyholders. That reinforces the suggestion of a possible gap in the regulatory framework (see paragraph 186) in relation to post-sales information to policyholders which the prudential regulator, as lead regulator for Equitable, might have been more proactive in seeking to resolve. That said, I do not see that, had they done so, that would have influenced these events in any significant manner.
198. I note also that the prudential division did not query the annual bonus of 5% that Equitable declared (in March 2000) for 1999, or the fact that their company accounts for that year included prudent provision of only £200m for GAR options. This was in contrast to the considerable wranglings FSA had had with Equitable around these two issues the previous year. I can only assume that this was because the company accounts were not usually subject to FSA review and the regulatory returns contained a provision of £1.6bn for GAR options (before reinsurance and resilience). Having accepted that the reinsurance would cover any additional GAR liabilities which might arise, FSA considered that to be a sufficiently broad safety net, certainly in respect of the reserving requirements. As for the 5% annual bonus, I note Equitable's view (in their report published on 22 March 2000) that no further reduction in bonus payment would be appropriate. This was in essence a commercial decision (a lower rate would have made them less competitive) and entirely in line with Equitable's standard practice of distributing surpluses. It seems to me that, if FSA had challenged them, Equitable could have argued that, given their well-publicised commitment to this approach and to not building up substantial free reserves, reducing the bonus further would not be in line with their policyholders' reasonable expectations. Whilst I can see, with the benefit of hindsight, that that might have been an opportunity for the prudential regulator to flag up with Equitable that it would be prudent for Equitable to build up some further reserves, given that they faced an uncertain future following the adverse Court of Appeal judgment and pending that of the House of Lords, in light of the circumstances at the time, I do not see FSA's decision not to press that particular matter at that point as unreasonable.
Should FSA have predicted the House of Lords' judgment?
199. It would not be accurate to say that FSA were taken totally by surprise by the House of Lords' judgment. As the relevant Director said (see paragraph 150), the ruling was unexpected but not unanticipated. FSA had featured it as part of their original scenario planning. However, the fact that it might go significantly further than the Court of Appeal judgment and rule out ring-fencing, was considered as a real probability only late in the day. As the Director commented, FSA did not consider that the eventual outcome was sufficiently likely for the regulator to act as if it would be the likely outcome. I do not see that in itself as a sign of poor judgment on FSA's part because the House of Lords' judgment effectively went against much accepted actuarial thinking and practice throughout the insurance industry and did not address the broader issue of the reasonable expectations of all policyholders, as required to be taken into account by the regulators. The fact that FSA's own legal advisers had asked whether ring-fencing could arguably be contrary to GAR policyholders' reasonable expectations (see Appendix C, 2 March 2000) might have alerted the prudential division to the possibility that the legal view of the position might differ from the view of the actuarial profession. Nevertheless, I do not see that earlier recognition of that as a clear probability would have influenced FSA's subsequent actions in any way.
00. What, if anything, should the prudential regulator have done differently in this period and would it have changed things markedly? Essentially, as officer H said (see paragraph 138), the prudential regulator's role in relation to the court case was to prepare for the various possible outcomes, not to predict what would happen. FSA's managing director also underlined the fact (see paragraph 155) that it was not for the prudential regulator to tell the company what action they should take. What they did have to do was to monitor Equitable's own scenario planning and ensure that they had assessed all the possible outcomes and the urgency with which they would need to respond. The prudential regulator also had to check that the actions proposed did not contravene statutory requirements or pose a serious risk to policyholders.
201. I cannot see that, if the prudential regulator had revisited their scenario planning two weeks earlier, when they received the first real indication that Equitable might lose in the Lords, it would have influenced events. It might be argued that they could have warned their conduct of business colleagues at that point, so that they could monitor more closely what Equitable were saying to potential (and indeed current) policyholders. However, given the conduct of business regulator's views on these events (see paragraphs 120 and 121), I am not convinced that they would have acted any differently, had the prudential regulator done so.
Period from the House of Lords' judgment (20 July 2000) to Equitable's closure to new business (8 December 2000)
Should FSA have allowed Equitable to proceed to sale, or should they have closed them down immediately?
202. This was, once again, a discretionary decision for FSA as prudential regulator. I cannot therefore question it unless it was reached maladministratively. My investigation has shown that, in considering this issue, FSA saw maintaining the value of Equitable as the most important objective and in the best interests of both current and future policyholders. Equitable, for their part, also wanted to try to get the best outcome for their policyholders and in particular wanted to acquire sufficient funding to enable them to repay the seven months of bonus withheld in response to the House of Lords' judgment, and possibly to make a goodwill payment to all policyholders on top of that. The only way that that might realistically have been achievable - if at all - was through a sale.
203. FSA took the view that it was not for them to say that Equitable should not put the company up for sale, as long as a sale looked like an achievable prospect. It was very clear from the evidence given by those officials involved that they strongly believed that closing to new business would have been very damaging to the value of the company and was likely to have eliminated completely the prospect of a sale. That view is supported by the professional advice I have received.
204. It is also true to say that FSA firmly believed - just as Equitable themselves did - that the company would find a buyer relatively easily. Indeed it was the general view of the insurance industry that Equitable would be able to realise their own expectations and be bought at a substantial premium. That view appeared to be well supported when Equitable received a significant number of expressions of interest. I understand also that the process followed the normal sales pattern, with the majority of the initial 15 prospective bidders dropping out over time until there were three serious potential bidders remaining. I have seen no evidence of any earlier indication which the prudential regulator should have picked up on during that period that the process might fail.
205. Equitable had also in the meantime (see Appendix C, 11 August 2000) been able to renegotiate the reinsurance agreement to provide financial cover if more than 60% of policyholders took up their GAR option. While this meant that the benefit of the agreement to Equitable was reduced, it did not affect their likely future profits, and helped to restore the regulatory solvency position to a certain extent. I note that FSA also continued to monitor the situation closely by asking Equitable for monthly solvency reports. With the benefit of hindsight perhaps FSA could have asked GAD for a note on the prospects for a successful sale, including any factors which might, singularly or jointly, lead to failure. That could have been done as a part of the scenario planning exercise to have informed FSA's decision as to the reasonableness of Equitable's proposed actions. Had that been completed, it might have alerted the prudential regulator at an earlier stage to specific issues which subsequently turned out to be significant factors in buyers' considerations (such as the difficulties which might be involved in preventing the growth of Equitable's GAR business - the top-ups issue).
206. But would such a piece of work have led the prudential regulator to have insisted on Equitable closing to new business immediately rather than attempting a sale? I do not think that it would. Given the high numbers of potential bidders and Equitable's reputation, I cannot see how FSA would have been able to justify immediate closure. Had they done so, they would have been heavily criticised for taking precipitate action when it was generally believed that the situation was still largely, if not wholly, retrievable.
207. Avoiding such criticism was not, however, the prudential regulators' main consideration (nor indeed should it have been). Their overriding objective (see paragraph 14) was to protect policyholders' interests by ensuring that Equitable remained solvent and able to meet their liabilities. I note in particular the comments of officer J (see paragraph 147) about the need to strike a balance between the interests of new and existing policyholders. He said that the prudential regulator had taken the view that the balance was overwhelmingly in favour of allowing Equitable to continue writing new business. If a sale had taken place as expected then all policyholders - new and old - would have benefited from it. I note also his reminder that, under the conduct of business rules, new policyholders could be compensated if they sustained loss as a result of joining on the basis of misleading information in breach of the relevant PIA rules. That point is, in my view, a key one, because it underlines the clear responsibility placed on companies to ensure that they make explicit the risks involved to potential and existing policyholders (who might be making decisions about possible changes to their current policy arrangements). If those purchasing or changing their policies were made aware of those risks but decided to proceed nevertheless, then that was a matter for them.
208. On balance, and in the light of all the evidence I have seen, I take the view that FSA's contention, that it would have been unreasonable to close Equitable to new business immediately after the ruling as that would simply have precipitated the situation that eventually transpired, and would have given Equitable no chance to save themselves, is a reasonable one.
Was there any other form of intervention that the prudential regulator should have taken at this point?
209. I note that the legislation allowed for a moratorium on new business for two months (see paragraph 32). This option does not appear to have been actively considered. I do not, however, consider that to have been an omission on FSA's part. Given the detailed discussions which had already taken place between FSA and Equitable over the previous year and more, and the scenario planning which had already taken place, I do not see what a delay of two months in putting that plan into action would have been likely to have achieved. As the Director explained (see paragraph 151), given that it had already been agreed that a sale would be the only real way of restoring, at least to some degree, the company's financial position, and therefore in the best interests of Equitable's policyholders, it would not have been sensible to have then imposed a moratorium which would inevitably have reduced the value of the company and potentially even have destroyed all possibility of a sale. In the light of the circumstances at the time, I do not consider that the prudential regulators acted unreasonably in not considering this as an option.
Were FSA wrong to have been so confident that a sale was possible?
210. Given that the prudential regulator's actions were significantly influenced by their belief that a sale would be achieved (not least that they allowed Equitable to remain open to new business on that ground), I turn now to the fundamental question of whether that was a reasonable assumption on their part. I understand that it was well known that Equitable had been approached by potential buyers several times in the past (see paragraph 151 - indeed the chronology also shows that in March 1999 they were approached by another mutual company seeking a merger). The very fact that so many potential bidders expressed an interest, and that three went on to have detailed discussions lasting several weeks, indicates to me that by no means could it be argued that FSA should have been expected to have realised at the outset that a sale was unlikely. I appreciate that FSA were, initially at least, perhaps somewhat more alert than prospective buyers to issues which might potentially raise difficulties (such as the top-ups issue which I deal with below). That said, the fact that the Society did not maintain a substantial reserve of free assets, which was Equitable's main weakness, was also, as I have already said, paradoxically one of their major marketing points, and following the high profile court case, the company's predicament with regard to their with-profits fund was also very well known. The fact of the matter was that Equitable's main selling points were their sales force, their information technology and administration systems and, significantly, their clientèle. The company's financial strength had never been a positive factor; on the contrary the weakness was by design, and was seen by them as a virtue in helping to ward off prospective predators.
211. The prudential regulator was however, as I have already indicated, aware of one factor which was not initially common knowledge, which was the difficulty in capping growth in Equitable's GAR business (the top-ups issue - see paragraph 185). The Treasury briefing to the then Economic Secretary on 6 December 2000 suggested that that was the main reason a sale had not taken place (see paragraph 100). If that was so, then should the prudential regulator have recognised that as a potential show-stopper from the start of the sales process?
212. I note the relevant Director's explanation (see paragraph 153) as to why it would be more accurate to describe the potential liabilities arising at that time from top-up payments into GAR policies as unquantifiable, rather than unlimited. Further, given that the serious bidders carried on in the sales process for some time after they had become aware of the top-ups issue, I also accept the Director's contention (see paragraph 159) that, while top-ups were a highly significant factor to potential purchasers, they were not in isolation a deal-killer. Equitable had addressed the issue in a paper for their Board, which they forwarded to the prudential regulator on 20 April 1999. In that paper, they had considered one method of restricting the potential growth in GAR business through the use of certain policy restrictions, but had determined that that would ot resolve the matter. Potential bidders had similarly spent a good deal of time formulating workable plans for how to cap the liability and, according to the Director, had eventually succeeded. Nevertheless they decided not to proceed to make a formal bid for Equitable.
213. I have seen from the papers that it was a combination of factors that caused the withdrawals from the bidding process, not all of which were related to Equitable's financial state. The companies' own portfolios and other business plans (such as the introduction of stakeholder pensions), as well as a growing pessimism about the potential for future growth in the life industry, together with then current stock-market trends, were all relevant factors contributing to those decisions. In all the circumstances I do not consider that it was unreasonable for the FSA to have taken the view that a sale was likely to be achieved.
But should the prudential regulator have stopped Equitable advertising as they did?
214. The position as the prudential regulator saw it was that responsibility for the management of Equitable and their business was primarily a matter for Equitable's Board. They had no powers to require Equitable to submit their advertising proposals to the prudential regulator in advance. Indeed the position as I understand it was that the prudential division could formally intervene only if they believed that the advertisements were likely to raise expectations for policyholders which Equitable would be unable to meet. They could then require Equitable to demonstrate that they had sufficient reserves to meet those expectations. I note that the conduct of business regulators seem to have recognised a role for themselves here and were also monitoring the position (see Appendix C, 27 October 2000), although they appear subsequently to have had some doubts about their remit in this regard, as evidenced in the prudential division director's briefing to the FSA Chairman on 6 November 2000. What is also clear, however, is that the advertising campaign that Equitable launched at this time was considered by many - including some relevant media financial commentators - to be lacking in balance and there were some complaints to FSA. The prudential regulator did actively consider those complaints (having consulted conduct of business colleagues on 4 October 2000) and whether there were any steps which they could take, but concluded (on 3 November 2000) that they could not reasonably require Equitable to stop advertising while there was still a realistic chance of a sale. I note further that the Treasury were also concerned about this and contacted FSA to ask if it was acceptable for Equitable to continue advertising in the way that they were. The Treasury clearly accepted FSA's explanation that it was reasonable for Equitable to expect to sell the business as a going concern and therefore to maintain their market presence in order to underpin their prospects for a successful sale.
215. Nevertheless, the prudential division did contact Equitable about the advertisements (on both 8 and 14 November 2000) and Equitable subsequently withdrew their new advertising campaign. As FSA were to explain to the Tripartite Standing Committee on 6 December 2000, it was not clear whether it was the prudential regulator's action that had caused Equitable to do so, or whether Equitable had made that decision in the light of the adverse press comments that had been made about the campaign. On balance, it seems to me that the prudential regulator did give this matter proper consideration but decided that, as Equitable were still meeting all the prudential regulatory requirements and any intervention could have made the position for policyholders worse (in that it might have impacted on the prospects for a successful sale), they had insufficient grounds for formal intervention. They decided instead to bring informal pressure to bear on Equitable. That was a discretionary decision on their part which, given the circumstances at the time, I do not consider to have been unreasonable.
Should the prudential regulator have required Equitable to put a 'health warning' on their products or advertising once concerns had been raised about Equitable's solvency position (November 1998), and particularly after the House of Lords' judgment?
216. It is quite clear from my investigation that the prudential division took the firm view that it was not reasonable to allow Equitable to continue trading, but then to require them to disclose to potential policyholders that there were concerns about the company's solvency, such that Equitable should not be viewed as a good investment. As they saw it, there was no half-way house; either the company was authorised to conduct insurance business or it was not. I accept that argument; particularly as intervention of the kind suggested, that is a 'health warning' on the product, might of itself have helped to push the company towards the very situation which the regulator was seeking to help them avoid, namely regulatory insolvency. In addition, by discouraging new business, such a warning could impact adversely on the returns that policyholders could otherwise expect. There also seems little doubt that requiring a special disclosure of that nature after Equitable had decided to seek a buyer would have affected the prospects of a sale, or at the very least the price a buyer might be prepared to pay. That in turn would undoubtedly have left the prudential regulator open to accusations of having torpedoed the sales process, and also to legal challenge by Equitable. In light of all that, I do not consider FSA's decision not to require Equitable to make such a disclosure to have been maladministrative.
Did the FSA as prudential regulator keep the conduct of business regulator adequately informed of Equitable's position during this period? Was there any other action which the FSA as prudential regulator should have taken at this time?
217. I note officer H's comments (see paragraph 137) that the prudential regulator recognised that they had to have regard to the risks to new investors, by requiring Equitable to close to new business if it was not, and had no immediate prospect of becoming, financially sound or meeting policyholders' reasonable expectations. However, the main concern for new investors would be if they were personally misled as to the state of the company - and that was in her view clearly a conduct of business, rather than a prudential matter.
218. I accept that, until the prospect of a sale fell through, the prudential regulator was unlikely to have had sufficient grounds for formal intervention on their own part, and I note that Equitable had assured them (see Appendix C, 1 December 2000) that the sales force had been adequately briefed and instructed to advise potential policyholders of the Society's circumstances prior to sale.
219. That left the question of whether the prudential division ensured that they had made their conduct of business colleagues sufficiently aware of the financial difficulties which Equitable were facing, in order that they could reach an informed view as to what action would be appropriate on their part. I recognise that the prudential division might have been reluctant to stray too far into their conduct of business colleagues' territory in this respect. I have considered, nonetheless, whether the prudential division should have impressed more strongly on their conduct of business colleagues the need for potential new policyholders to be reminded that there was a caveat on Equitable's future health, should a sale not be achieved. With the benefit of hindsight it is easy for me to say that they could have done so. But I do not feel able to say that any prudential regulator acting reasonably should have done so; and overall I am satisfied that the prudential division kept the conduct of business regulator adequately informed of Equitable's position.
220. I am also mindful of the likely consequences had the prudential regulator been more proactive and insistent on this point. In light of the evidence given by conduct of business staff (particularly officers D and E - the then head of the conduct of business division and the relevant director), that where a firm had not breached the regulatory solvency margin, there would be no grounds on which the conduct of business regulator could require them to make a special disclosure as to their overall financial position on top of the disclosures a company were required to make under PIA rules, I cannot say that that would have made any difference. It seems very clear to me from officer D's comment that the conduct of business division would not have expected their prudential colleagues at that time to have alerted them until the statutory solvency margin had been breached (see paragraph 119), and their comments when consulted about the advertising (see Appendix C, 4 October 2000), lead me to believe that they would not have considered a 'potential future regulatory insolvency' sufficient ground under the PIA rules for them to intervene. As the conduct of business regulators are outside my jurisdiction, I cannot comment on whether or not that attitude was an appropriate one for them to take.
Was it reasonable for FSA to have recommended agreement to the section 68 application which Equitable submitted in June 2000 for a future profits implicit item of £1.1bn to use in their year 2000 returns?
221. The prudential division's recommendation to the Treasury on this was, as usual, based on the advice they had received from GAD, their professional advisers. That advice, however, predated the House of Lords' judgment. I have seen no contemporary evidence that GAD reconfirmed that the earlier advice remained valid after the judgment, but I accept the accounts of GAD and FSA officers (see paragraphs 125 and 132) that they did so. In the event, given that these items are largely based on conservative estimates of returns on existing business, I can see why FSA's prudential division felt that the House of Lords' judgment did not significantly change the position (see Appendix C, 1 September 2000). That said, the application effectively went through the Insurance Supervisory Committee without debate and I note that the Committee did not feel the need to discuss it further when invited by the chairman on 11 September 2000 (see paragraph 88). Given Equitable's by then obviously precarious position, I considered whether that application should have attracted closer scrutiny. I concluded, however, as before (see paragraph 177) that, given that the item was allowed under the regulations and that it fell well within the margins for which Equitable could have applied, it is difficult to see how the prudential regulator could have reasonably recommended refusal. If they had, Equitable would have been well within their rights to have challenged such a decision. Furthermore, given that the item in question was for use in the 2000 regulatory returns (due in June 2001) and did not therefore come into use until after the sales process had ended and Equitable had been closed to new business, I do not see that, had the prudential regulator scrutinised the application more closely, it would have influenced events in the period under investigation.
What of the "deep-seated oversight" to which the Treasury briefing referred?
222. That remark was made in a briefing note from a Treasury official to the Economic Secretary on 6 December 2000 (see paragraph 100). The briefing suggested that the oversight was in failing to ensure that Equitable had proper risk management processes in place, but that this had become highly significant only after the House of Lords' judgment in July 2000. It is evident from the interviews my staff conducted (see paragraphs 106, 115, 148) that there are differing views as to exactly what was meant by that comment and how informed a view it was. Given the extensive level of contact that the prudential regulator and their professional advisers had had with Equitable throughout the period under investigation, particularly in seeking to ensure that Equitable had sufficient reserves in place to protect their policyholders against the risk that they might not be able to pay valid claims, it is not entirely clear to me either what was meant by that remark. If one accepts officer A's interpretation (see paragraph 106), it was effectively an observation that prudential regulation was not as demanding as other financial regulation. As it was the Treasury's responsibility, having contracted out their prudential regulatory functions to FSA, to monitor FSA's performance in respect of those duties, and the Treasury had apparently had almost daily contact with FSA (see paragraphs 104 and 111), then if this was intended to be a comment on the performance of the regulators rather than on the regulatory framework, I would have expected the Treasury to have raised this with FSA as an issue before. Indeed I note that the then Treasury director of the financial sector said (see paragraph 111) that they had been satisfied that the prudential supervision had continued to be carried out as envisaged under the Contracting Out Order. I do not therefore consider that remark to have been a considered and informed Treasury view of events.
223. Nevertheless, the comment does serve to underline the fact that the view taken of the prudential regulator's actions will depend in large part on what is expected of their approach. It was clear from FSA's agreement with the Treasury setting out key tasks (see paragraph 17) that there was no expectation that there would be a major change in the way in which prudential supervision was conducted during the run-up to FSA taking on the overall regulation of the sector. The regulatory role was seen primarily as a monitoring one, and was based largely on scrutiny of financial returns (with GAD's support). It was therefore heavily reliant on companies providing accurate and comprehensive information, and it was basically reactive.
224. I note officer A's comment that, with the benefit of hindsight, it had become evident that Equitable's assessment of their own position had been superficial (see paragraph 108). As a result, despite all the exchanges the prudential division and their professional advisers had had with Equitable over time, FSA had not appreciated the extent of Equitable's problems until they had become apparent during the bidding process, when their accounts had been opened up to significant and detailed scrutiny. However, I note that that was a far more detailed and in-depth scrutiny than that which would, or indeed could, usually be carried out by the prudential regulator. (I can make no comment on the professional advice (from GAD) that the prudential regulator received in respect of Equitable's financial situation, as GAD and their actions are outside my jurisdiction.) The detailed chronology clearly demonstrates that FSA did press Equitable very hard on a number of issues. It is also clear that, for example on the question of reserving for GAR liabilities, Equitable thought that the regulator was being unreasonable and requiring them to adopt what they saw as a "wildly prudent" approach that did not sit well with the whole ethos of their company (I note that they even complained to the then Economic Secretary to that effect and threatened judicial review). Indeed the actuarial opinion I have received (see paragraph 158) suggests that FSA may have been requiring the whole industry, Equitable included, to adopt an approach to reserving that was significantly more prudent than the industry itself believed was necessary. Despite that, FSA maintained a strong stance and made it quite clear to Equitable that they would intervene formally if Equitable did not comply.
225. My investigation has also revealed that throughout the relevant period Equitable received a significantly greater proportion of the prudential regulator's attention than many - indeed if not all - other insurance companies. I note officer J's comment (see paragraph 142) that he could not recall the regulator having ever gone so far in seeking to influence a company's bonus decision as they had done in Equitable's case. Such was the level of contact that it led to Equitable being chosen as an early candidate for the new technique of co-ordinated risk-based supervision (under the lead supervision arrangements).
226. I note also FSA's view, supported by their legal advice, that under the prudential regulatory framework that then existed, they could act formally only if a company took action which would breach the statutory rules; and that otherwise, their role was to help identify emerging problems and issues, and to work with the company in question to get them through that and back to a sound financial base. It was not the prudential regulator's role to make companies' decisions for them (which might be viewed as the regulator acting as a 'shadow director'), but to ensure that companies were aware of how the regulator would respond to decisions the company might make. I note also that the agreement under which FSA operated (see paragraph 11) made it explicit that their role was not to seek to achieve 100% success in avoiding company failure; it was recognised that this was neither realistic nor necessarily desirable. FSA's aim was to minimise, but not eliminate the risk of company failure by identifying early signs of trouble and taking preventive action. Given the regulatory framework within which the prudential regulator was then working, and the legal advice that they received about their powers of intervention, I do not consider that that approach was an unreasonable one for them to have taken.
What of the Treasury's responsibility throughout the whole affair?
227. I was concerned from the comments made in interview to my officers that the Treasury might have taken the stance that, in contracting out this area of work to FSA, they had thereby delegated all responsibility for prudential regulation. I noted in particular the views expressed by officer B (see paragraphs 110 and 112) that, as all staff with expertise had transferred to FSA, the Treasury could not query their supervisory judgment; they simply needed to know that prudential supervision was being carried out as before. I accepted that it would not have been appropriate for the Treasury to duplicate FSA's own activities or to seek to substitute their own judgment for FSA's. Nevertheless, I could not see how it would be possible for them to fulfil their own responsibilities in this respect unless they had maintained at least some in-house expertise, sufficient to act as an 'intelligent customer' in relation to monitoring FSA's performance under the service level agreement.
228. I was unable to establish the position from the Treasury's own papers because there was little documentary evidence of any contact with FSA during the relevant period. I noted that several officers referred to almost daily contact on prudential matters, both in terms of e-mails and telephone calls, but said that they did not keep records of these (see paragraphs 104 and 111). The only firm evidence of monitoring of FSA's performance that I found was that carried out through the quarterly meetings. I note that even then there seemed to be conflicting views as to the purpose of those meetings. The Treasury officers (see paragraphs 104 and 111) said that they were to discuss matters of significant concern or which might pose a threat to the insurance industry, whereas officer J, in explaining why Equitable did not feature on the agenda in March and June 2000 (see paragraph 144), suggested that the purpose of the meetings was to raise matters that would otherwise have gone unreported (on the grounds, I can only assume, that they were of lesser significance).
229. As it was the Treasury's duty to intervene if they believed the approach being taken by FSA to prudential regulation, and specifically to the Equitable issue, was inappropriate, I asked the Permanent Secretary to explain how the Treasury had carried out their monitoring responsibilities. He explained that the Treasury's policy was that the system of regulation in place under the contracting-out arrangements should anticipate, so far as was possible, the coming into force of the new Financial Services Management Act regime. The retention of significant numbers of staff with regulatory expertise within the Treasury would have prevented that. Nevertheless, the relevant staff in the Treasury at the time in question had many years' experience of financial services work, indeed one of the key Treasury officers had transferred to the Treasury from DTI along with responsibility for prudential regulation in January 1998 (paragraph 11). It could not therefore be argued that those officers did not have the necessary expertise to act as an 'intelligent customer'. However, their role had become more 'arms-length' in that they would only seek to intervene, or question how FSA were carrying out their functions, if it seemed to them that a matter was novel, unusual or particularly contentious, that is something outside their normal framework. The Permanent Secretary went on to say that he accepted that the lack of contemporaneous records had made it difficult to demonstrate the monitoring action being taken by the Treasury and the regular contact that there had been with FSA throughout this period. He said that the Treasury were currently reviewing their record-keeping practices. He added that they had also agreed with FSA that they would hold quarterly meetings, rather than receive quarterly written reports (as required under the service level agreement).
230. One area where my officers did find evidence of contact was in relation to section 68 applications, although it was unclear what level of scrutiny these were given. The Treasury officers (see paragraphs 104 and 114) insisted that these were not simply rubber-stamped but were looked at carefully. While I have seen no direct evidence to support that, I have no reasons to doubt the officers' accounts. Overall, and in light of the Permanent Secretary's explanations, I am satisfied that the Treasury fulfilled their responsibilities in respect of prudential regulation during the period under investigation.
Overview
231. The events preceding the closure of Equitable to new business raised a fundamental question as to the role of the prudential regulator and where the balance of responsibility lies in terms of a company's management of its financial affairs. There were a number of different bodies which all had duties and responsibilities in this respect, namely the Board and managers of the company, their appointed actuaries, their auditors, and of course the regulators. The actions and decisions of all those other parties would have contributed to a greater or lesser extent to what happened. It is not possible, given the limits on my jurisdiction, for me to reach a considered and balanced view of the significance of each of those contributions simply by looking at one constituent part. Nor is it for me to determine where the balance of responsibility should lie between those bodies for what happened in the case of Equitable. I am only able to consider the actions taken by the prudential regulator.
232. Throughout this whole period FSA acting as prudential regulator on behalf of the Treasury constantly had to assess and reassess whether formal regulatory intervention was warranted, in particular whether they had sufficient grounds for intervention. Given that such intervention was likely to have a significant impact on Equitable's future profitability and even viability, could therefore impact adversely on policyholders, and would probably provoke legal challenge, it was clearly not action to be taken lightly.
233. I am satisfied from my investigation that FSA carefully monitored Equitable's regulatory solvency throughout this period, and that at no time was Equitable's financial position such that they had breached the regulatory solvency requirements. Another possible ground for intervention by FSA was if they believed that Equitable were unable to meet policyholders' reasonable expectations. I am satisfied that it would not have been appropriate for them to have taken a decision on intervention in respect of Equitable's differential terminal bonus policy while that matter was before the courts. However, the position changed dramatically once that process had concluded adversely for Equitable. FSA then had to reach a difficult judgment as to whether to close Equitable to new business or let them try to sell the company as a going concern. Given that the regulator's primary objective is the protection of policyholders' interests (see paragraph 15), and that FSA believed that to allow Equitable to put themselves on the market would at least enable Equitable to try to get the best outcome for all policyholders, I cannot say that their decision not to intervene by requiring Equitable to close to new business was outside the bounds of reasonableness. I should, perhaps, add that, had FSA intervened formally at that stage, when it was strongly believed that a successful sale (which might have enabled Equitable to have worked their way through their then current difficulties) was virtually certain, I am satisfied that that would have prompted a public outcry on the grounds that the prudential regulator had severely misjudged the situation and that their intervention had been inappropriate. I cannot therefore say, on the basis of the evidence I have seen, that any of the decisions the prudential regulator reached in respect of the exercise of their formal intervention powers were unreasonable or fundamentally flawed such that I would consider them to be maladministrative.
234. Whilst I am satisfied that the judgments made by the prudential regulator were not maladministrative, with the benefit of hindsight, I have identified in my report a number of occasions when FSA, in their role as prudential regulator, might have done things differently. There were, for example, times when FSA might have been prompted to delve more deeply into aspects of Equitable's financial situation, which might have given them a more realistic view of the problems Equitable were facing and of the likelihood of a sale. But I cannot say, if they had been more proactive in those areas and reached a more informed position earlier, that FSA would have reached different decisions about awaiting the outcome of the legal process before deciding to act, or on whether to allow Equitable at least to attempt a sale. From the evidence I have seen I am not persuaded that the failure to achieve a sale was based wholly or mainly on factors relating to Equitable's financial position which the regulator should have unearthed at an earlier stage. FSA's papers indicated that the potential buyers withdrew for a much broader combination of reasons, including commercial considerations and a recognition of the growing difficulties facing the life industry in the face of a continuing and significant downturn in the investment markets.
235. These events also highlighted a number of areas of concern relating to the regulatory systems and framework. I note in particular the apparent limits on the information required to be disclosed in the regulatory returns, which seemingly allowed the extent of GAR liabilities to go unrecognised for so long; and the accepted use of future profits implicit items in the regulatory returns (as laid down in the EU Life Directive) to offset liabilities. Those were, however, lawful actuarial and accounting practices within the contemporary regulatory system within which FSA did not always have powers to intervene, and which are in any event, outside my remit. Nevertheless, I note that those and other perceived weaknesses in the systems and framework are being addressed, as FSA's response to the Baird recommendations demonstrates (see Appendix B).
Mr P's complaint
236. What of Mr P and others like him, who contend that FSA's shortcomings meant that potential investors were unable to make fully informed decisions when purchasing new policies or annuities? I have found that the prudential regulator did consider what action they could take in the light of the potentially misleading nature of Equitable's 1997 returns (see paragraph 170), and that they pressed Equitable to adopt measures to improve their regulatory solvency position. As I have already made clear, the responsibility for what individual potential investors were actually told when purchasing new policies or annuities was not a matter for the prudential regulator. This was a responsibility set primarily on the company themselves and was a matter for the conduct of business regulator to police under the relevant PIA rules. Additionally, given all the publicity surrounding Equitable's high profile court case and their subsequent decision to put the company up for sale, I would have expected potential investors to have sought independent financial advice before investing in Equitable.
237. As for the prudential regulator, as I understand it, the only way in which that regulator could otherwise have helped to shape the views of potential investors as to whether or not to invest in Equitable (short of closing Equitable fully or to new business for a period of two months or more - and I have explained why FSA's decision not to do that was not in my view unreasonable) was by putting greater pressure on Equitable to present their situation in a more balanced and measured way. They might have considered requiring Equitable to put a health warning on their products, but as I have indicated in paragraph 216 above, it was FSA's view that that was not reasonable so long as the company remained authorised to conduct business; and such action was likely, in any case, to have affected existing policyholders' reasonable expectations (by discouraging new investment) and to have had the same negative effects as closure on the company's saleability. What I can say is that, on the basis of the limited evidence I have seen (given that Equitable themselves are outside my remit and I have not examined their papers) I have found nothing to suggest that Equitable would have been persuaded by the prudential regulator to introduce warnings sufficient to deter potential new investors like Mr P. In light of that, and of the fact that I have not found that FSA were maladministrative in their role as prudential regulator, I do not uphold his complaint.
Conclusion
238. Whilst I have identified several things which FSA in their role as prudential regulator might have done differently, I am not persuaded that the decisions that they took were unreasonable, or that they failed to carry out their regulatory duties appropriately. Nor am I persuaded that any action or inaction on FSA's part significantly influenced the outcome of these events. I can fully recognise the outrage that Mr P and others in his position clearly feel, that a life assurance company of Equitable's former standing and reputation should, in the course of a relatively short period, reach a position of having to close to new business and significantly cut policy and annuity values, and the consequent significant financial loss policyholders and annuitants have suffered. I very much sympathise with those policyholders and annuitants in respect of the financial difficulties in which they now find themselves as a result. Nevertheless, I am satisfied that the actions of FSA, acting as prudential regulator on the Treasury's behalf, were not maladministrative and cannot be said to have caused the injustice, whether by way of financial loss or otherwise, which Mr P alleges.
