Examination of witnesses (Questions 160
- 186)
THURSDAY 14 MAY 1998
MR HOWARD
DAVIES, MR
RON DEVLIN
and MR ROGER
BRIGHT
160. Is that what actuarial skills are all
about?
(Mr Davies) I am happy that comment is on the
record under your name, Mr Bruce!
Chairman
161. You could not possibly comment!
(Mr Davies) I could not possibly comment, no!
We had to take a view and we thought it right to take a view because
obviously there is market sensitivity about what regulators say
in relation to the overall cost of this exercise, which may be
thought by some to be material in market terms. We therefore,
in our consultation paper, gave it our best shot. As I have said,
the headline was that we believed in the light of our experience
in the first phase, and what we therefore expected in the second
phase, the nearest we could get was that the total all-up cost,
including compensation in the first phase, compensation in the
second phase, the costs of both phases to the industry, would
be somewhere between £8 and £11 billion, the uncertainty
being on the number of cases that come in for review and the number
of cases where redress is eventually decided on and indeed how
much that redress is. You will have seen from the figures which
I discussed with Mr Clarke that there are quite a lot of cases
which come in and for which no redress is due. The only way in
which you can produce a bigger figure is if you say, "Actually
everybody will want their case reviewed and everybody will be
eligible for compensation". We just think that is completely
implausible and is not supported by the evidence of the review
so far.
Mr Bruce
162. It is still a very large amount. I
know you relate it to the total assets but I think most people
look at the absolute sum rather than what it relates to and indeed
how it might impact. If I can refer you, first of all, to an exchange
I had with the Minister last week on this issue, I was trying
to establish how this should be distributed particularly within
non-mutual companies between shareholders and policy holders,
as Mr Davies has been pointing out, and the Minister to my surprise
replied, "Basically, it is up to the companies to tell us
how they are going to fund the results of mis-selling." This
is a pretty unsatisfactory state of affairs, is it not?
(Mr Davies) Yes. I can quite understand that these
are very large sums and this is the most mysterious aspect of
it and you are right to say that even though I said 2 per cent,
it is still large. It reminded me of President Reagan who once
memorably remarked, "A billion here, a billion there, pretty
soon you are talking real money"! Certainly in this case
it is real money. However, it is the case that under the present
law it is for companies to determine how they will pay that, subject
to this requirement to meet policy holders' reasonable expectations.
However, I think I would have to say that policy holders' reasonable
expectations are not defined in statute anywhere. The term and
the meaning of that term has been built up over time and it has
some concrete meaning to it in that it should relate to what the
company told policy holders they would meet, et cetera. Now, at
the moment companies are saying that they do not believe that
the pensions mis-selling review will affect their ability to meet
policy holders' reasonable expectations. Now, you may say, "Well,
how can they say that?" Well, the reason they can say that
is because there are large free estates in most of these life
funds. Now, then I can see you say, "Well, what do you mean
`free estates'?" but there is some debate about to whom those
estates belong. Ultimately, I think that the generally accepted
view and the practice which has been adopted when issues of how
to distribute free estates have been addressed has been that they
belong as to 90 per cent with policy holders and 10 per cent with
shareholders. That has typically been the view when it has been
necessary to attribute these estates, so I suppose it is logical,
and in a sense this follows from what Mr Davies was saying, that
if you have a lower free estate than you otherwise would have
had as a result of pensions mis-selling, then at the end of some
very long track, that would be distributed between the policy
holders and the shareholders in the way I suggest.
163. I speak as a humble policy holder,
but I have two reasonable expectations, it seems to me. One is
that if my money is invested by the company and makes a profit,
then most of that profit is going into my policy, not into the
shareholders' pockets, unless it is a mutual company, in which
case I am a shareholder as well, and, secondly, that the return
to the shareholders should be based on a reasonable return on
capital and the cost of administration and managing the business,
not helping themselves to part of the profits which have been
invested on behalf of the policy holders, and yet that does appear
to be what the current arrangements seem to allow for, particularly
in the context of action by the management which everybody has
now regarded as a blatant abuse.
(Mr Davies) I think that the current regime does
broadly deliver the two expectations that you have and I would
say, as I did say a few minutes ago, that here I am commenting
on the regime which we have to know something about because it
does influence in some ways the prosecution of the pensions mis-selling
review, so we have to take this into account in determining how
to prosecute the review, but we have no control over that regime
at the present time and that is currently the Insurance Directorate
of the Treasury's regime. In due course, on the passage of the
next Act, it will become one of my responsibilities, but I think
it only right for me to say that it is not at the moment.
164. So that is the lacuna that Mr Davies
was talking about. The Consumers' Association have given us a
memorandum in which they say, "Our main cause for concern
is the lack of legislation on the ownership of assets in life
insurance funds", and they comment, "It is unacceptable
that a number of insurance companies have decided to use policy
holders' assets from life funds rather than shareholders' funds
to pay compensation to victims of pensions mis-selling".
That is the view of the Consumers' Association. Do you take the
view that it is unacceptable and do you take the view that there
needs to be clarifying legislation and it does seem odd that you
have your role and the Treasury is operating quite separately?
(Mr Davies) I think that the lacuna, which I feel
competent to talk about and, as it were, competent also to fill,
is the one about the responsibility of management for this matter
and that is what we have attempted to fill and PIA has attempted
to fill through individual registration and that will be carried
forward into the Financial Services Act regime. I have to say
that at this point I think your question about the regime applying
to the prudential regulation of insurance companies is really
a matter for Treasury ministers.
165. What you are really saying on this
particular issue as to who ultimately is going to pay the costs
of mis-selling is that it will be history by the time the powers
are defined as far as your organisation is concerned.
(Mr Davies) No, I think that is not quite what
I am saying. I have to accept that my individual registration
powers cannot be used with retrospective effect, but the question
of the distribution of these free assets, if you like, is one
which remains open and one which is essentially the responsibility
of prudential supervisors of insurance companies and the current
position was as set out by Mr Nigel Griffiths in his reply.
166. But this of course is presumably why
the insurance companies are actively engaged in discussions with
the Treasury at the moment in order to get it resolved sooner
rather than later, so we understand.
(Mr Davies) I am not involved in those discussions.
Mr Cousins
167. Mr Davies, you said earlier that there
were a number of cases in which you had identified a complete
absence of record-keeping, and that was your phrase to the Committee.
How many cases of that kind were there?
(Mr Devlin) In the context of the review generally
or the conduct of this business generally? Well, the primary source,
the initial source of evidence was the KPMG Report in 1993 which
found material non-compliance, pervasive non-compliance certainly
at the record-keeping level virtually across the industry, and
something like 80 or 90 per cent of the cases that were reviewed
for that purpose were found not to meet the standards of the day
and subsequent monitoring and subsequent experience of the review
supports that position.
168. That of course is alarming enough,
but the phrase used by Mr Davies was "a complete absence
of record-keeping". Mr Davies did say that he had little
sympathy—I think that was his term—for people who
had a complete absence of records. How many people do you know
about had a complete absence of records?
(Mr Davies) I used that phrase and I would be
surprised if it were not true in some cases, but I think it would
be unfair to pursue Mr Devlin on how many because I do not think
we have ever asked that question. What we have asked is how many
of these people are compliant with the standard and the degree
of non-compliance could range from not quite compliant to having
absolutely nothing to show.
169. Mr Davies, it is a serious business
to come to a Committee of this kind and use a phrase of that kind
which you have used. You said "a complete absence of record-keeping",
and the Committee is entitled to know, if not now then later,
how many cases you have found or PIA have found where there is
a complete absence of records. The Committee, I think, is also
entitled to ask how many of the people where there was a complete
absence of records are still in business, so do you happen to
know that?
(Mr Davies) I think what we certainly would try
to do to help the Committee would be to look at what we know of
the cases that we have addressed and give you some information
about the standards of record-keeping in those cases, but I would
be surprised if we identified the people whose record-keeping
was non-existent that we would be comfortable for them to stay
in business, but I could not give you an answer on every case.
170. Well, I am sure the Committee is very
reassured to know that you have little sympathy with the fact
that people could have a complete absence of records, and is probably
even more reassured to find that you would not be very comfortable
with the idea that they are still in business. What the Committee
wants to know is how many of these people did you find who had
a complete absence of records and whether they are in business
now, and perhaps at some later date you could provide the Committee
with that evidence. Now, have you heard of a practice, Mr Davies,
of paying directors bonuses on the basis of earnings per share?
Have you heard of that practice?
(Mr Davies) Yes.
171. Would you say that it incentivises
commission-taking and the loading of costs on to policy holders'
funds?
(Mr Davies) I think that the question of how you
strike a profit is at the heart of that question and that would,
as it were, come before the question of distribution of that profit,
so I think that would not necessarily speak to the point about
how you dealt with the distribution between policy holders and
shareholders because, depending on how you constructed what your
profit calculation was, it could be, as it were, pre-distribution
or post-distribution. I think that therefore it would not necessarily
create the incentive to which you refer.
172. It would not necessarily create it,
but it could create it?
(Mr Davies) I guess an EPS calculation would normally
be based on accounting profits and not on retentions for shareholders.
So if it were based on retentions, then there would be an incentive
for management to maximise those retentions, but I would hope—and
it is not my business to regulate payments to directors of insurance
companies—that companies would devise payment schemes which
did not create an artificial incentive to retain because I think
that would obviously be subject to the challenge that you describe.
I think they would be more likely to use either share option schemes
which were based on the share price or long-term incentive plans
which would be based on a long-term view of the profitability
of the company, but as I say we do not monitor that information.
173. You do not monitor it? You do not have
to know about this?
(Mr Davies) No, it is not our business——
174. Whose duty is it to see whether malpractice
is incentivised and whether a loading of costs on to policy holders
is incentivised by payment systems? Whose duty is it?
(Mr Davies) I think the shareholders have some
duties in relation to the company, obviously. There are codes
of practice which have been devised in the market place and by
the CBI and others which give guidance to companies and to their
shareholders about good practice and remuneration schemes, which
certainly points to the need to avoid——
175. In this particular respect which we
are talking about?
(Mr Davies) I think it would be fair to say not
in this particular respect. The only other point I would say is
that the Secretary of State, in this case now the Treasury, under
the Insurance Companies Act does have the power to intervene to
protect policy holders if the company is not meeting the reasonable
expectations of those policy holders.
176. What troubles me about this is when
I asked last week the insurance man from the former DTI, now the
Treasury, about this he said that not once in the entire time
they had had those powers had they used them, but you are saying
we should go back to them? That they are the people with the duty?
(Mr Davies) Yes.
177. That is very helpful. Turning to your
consultation paper, your consultation paper reveals well over
400,000 cases where people were sold pensions on the basis solely
of a rebate from a national insurance fund. Only 20,000 of those
cases are actually the priority cases from 1994, so over 400,000
of those cases remain to be dealt with. Prima facie, would
you not think that selling somebody a personal pension solely
on the basis of a rebate from the national insurance fund is a
legitimate object of inquiry?
(Mr Devlin) Given the circumstances and the Government
incentives at the time, it was a good deal for the vast majority
of investors who contracted out of SERPS into a personal pension.
The vast majority who did so have done well thereby, and that
was part of the intention and the product of the Government scheme
of the day. The issue here is what should have been the position
of individuals who were contracting out on the basis of rebate-only
pension policies where there was an occupational pension scheme
available to them. The issue is whether they should have been
within their employers' occupational scheme or not.
178. Your report here identifies well over
400,000 people, and your estimate of their losses is in excess
of £2 billion, who were sold pensions solely on the basis
of rebates. I think that is the point at issue, solely on the
basis of rebates. I find it rather curious that your suggested
questionnaire never raises the issue of what advice might have
been given to people who were sold pensions solely on the basis
of national insurance rebates, that point is never enquired into
in your questionnaires, "Do I want my case checked?"
You have not got a single question about this.
(Mr Devlin) The questions there are directed to
understanding the motives or suggesting consideration of what
might have been the motive of individuals who had taken those
policies relative to the availability of an occupational pension
scheme.
179. I find it a bit odd——
(Mr Devlin) It is a very focussed purpose and
the issue primarily here within this consultation is not whether
or not it was a proper thing for them to have contracted out of
SERPS into a rebate-only policy, the issue really is when they
were doing that were they aware of an occupational pension scheme
of which certainly to their advantage they could have been a member.
180. But you have identified 400,000 of
these cases where people were sold personal pensions on the basis
solely of rebates from the national insurance fund and you have
projected their losses at £2 billion, and your questionnaires
do not cover this point.
(Mr Devlin) The losses we are projecting there
are in relation to an alternative which would have been available
to some at least of these people of being a member of an occupational
scheme. The number of individuals who contracted out of SERPS
into rebate only policies is far, far greater than 400,000. As
I said, SIB research in 1996 established that between 95 and 99
per cent of those individuals have profited from that exercise.
181. I would be grateful if you could send
to the Committee some information on how we can compare 400,000
rebate only personal pensions with their losses of £2 billion,
with some other much larger category of rebate only pensions where
people have not experienced losses. That would be a very interesting
piece of information. This does, of course, directly raise the
point as to the part commissions play in this whole exercise.
What powers are you taking, what advice are you offering, about
commissions?
(Mr Davies) Undoubtedly, it is true that commission-driven
selling contributed to this process. I think that the experience
of this review has caused a number of firms to think very hard
about the way in which they compensate their sales forces, and
indeed we know in quite a number of cases they have changed radically
the basis on which they compensate their direct sales forces as
a result, because they recognise they had generated incentives
for sales people to sell policies quickly to people for whom they
were unsuitable and for the first time in this review it has become
evident through the regulatory system that the costs of that will
rebound on the company in due course. So some of the people who
are most steamed-up about changing the basis of remunerating insurance
salesmen are now the companies who realise this has cost them
a lot of money, the salesmen concerned may have made very good
earnings for two or three years and then gone off somewhere else
and the company is left to pick up the pieces. As far as we are
concerned in relation to the individual investor, we have said
that in many cases the investor would be better served by fee-based
advice. The difficulty is, however, that it is not realistic to
think of making that a mandatory way of paying for advice, because
there are some people for whom that would not be an affordable
proposition in the short-term; there are some people who would
not have the funds to pay for advice on the basis of the fee up-front
and for whom it may be reasonable, as long as they are given decent
advice, to pay for that via commission through an IFA or whatever
over a period of time. So we cannot require it, but we have pointed
out to people that there is obviously a risk if you are accepting
products on a commission basis, you need to be quite rigorous
about asking what the basis of that commission is, that commission
must be disclosed to you, so you can take account of that in making
a decision.
182. This will obviously be an important
issue for the Committee when we come to look at stakeholder pensions
and individual savings accounts and matters of that kind, so it
would be very helpful to the Committee if you could give whatever
facts you may have at your disposal about the practices of the
past, how they have changed, who has changed them, and why, and
that will provide us with some guidance to inform our view of
how these new initiatives should be proceeded with.
(Mr Bright) If I could just add a point to what
Mr Davies has said, when we monitor the firms that come within
our purview, one of the factors that we take into account is the
way in which they remunerate their sales force and, therefore,
if they are operating entirely on a commission-only basis, we
certainly look carefully to make sure that there is no evidence
of commission-driven sales, so it is something that we are alert
to.
183. So that means in fact that you could
provide the Committee with an analysis of providers, with the
practices that they adopt with regard to commissions and you could
identify for the Committee those companies that reward their employees
or their agents solely on the basis of commissions?
(Mr Bright) Providing there are no problems of
commercial confidentiality.
(Mr Davies) We would have to look at the commercial
side of that, but I am sure we could give you quite a lot of what
you would need in order to make some judgments on that.
184. How do you view the idea of kite-marking
products?
(Mr Davies) I think that the immediate answer
to such a question is always to say, "It depends what you
mean", but I am afraid it does depend what you mean. We would
be very nervous, I think, about kite-marking which implied that
this product was suitable for anyone because the whole learning
experience of the last ten years of financial regulation has taught
us, I think, that suitability is at the core of the problem that
investors face, whether this is the suitable product for you,
and no scheme of kite-marking can really address the question
of whether this is a suitable product. Now, if we sort of step
back slightly from that into bench marking, first of all, I think
it is important to say that in the life area, under the third
Life Directive, it is not possible to require products to meet
certain benchmark standards of cost disclosure or whatever, but
it would be possible to say, "Here are marks on the bench
which are how you ought to disclose your commissions" and
you might say that commissions above X per cent were quite high,
or you might say that this is a sort of industry standard and
I think that kind of area of bench marking is a feasible way forward
as long as people accept, one, that it does not imply any guaranteed
return because as soon as you get into an area of a life policy
or equities, you cannot guarantee a return and, two, as long as
people understand that it does not imply that this product is
necessarily suitable for them. So we think there could be some
mileage in bench marking in the sense of standardising disclosure,
that this is a "no surprises" product, if you like,
and that kind of thing strikes us as being potentially quite interesting
as a way forward in regulation, but kite-marking in the sense
that "This is a very good deal for everybody" seems
to us to be unlikely to be a good way forward.
185. So in the sense that it is quite commonly
talked about at the present time, you would not be in favour of
kite-marking future stakeholder pensions?
(Mr Davies) As I say, if that implied that these
pensions were suitable for everybody, we would be very nervous
about it indeed.
186. That is a very interesting reply and
a very helpful reply, but have you applied your mind to what kind
of advice ought properly to be given then to people who took out
future stakeholder pensions, future ISAs, personal pension plans
at the present time? Could you provide the Committee with some
guidance on what you would think is the appropriate advice that
should be given to people?
(Mr Davies) On stakeholder pensions, I think the
honest answer is that I could not because the Government have
not yet produced a design for stakeholder pensions on which we
could advise on the regulatory features. In due course, I am sure
that they will and in due course we will offer a view on how we
think they should be regulated if they are in the advice area.
Obviously if they were to be compulsory, and I am talking purely
on what I read in the newspapers, then that is a different question
altogether. If it is a question of you have got to have one, the
question of suitability is a second-order issue. On the case of
ISAs, we will be publishing around the end of this month a consultation
paper on the regulation of ISAs and the regulation of the different
parts of it. I think that the principles of that will follow from
the principles we seek to use in the retail area already—principles
of good disclosure, comprehensible disclosure, not only of costs
and charges but also the risks involved in the different elements
of the product. But, as I say, we will be producing a consultation
paper on that which our board is looking at next week.
Mr Cousins: I am sure
our Chairman will want me to stop, on the basis we will have an
opportunity to return to these matters joyously on a later occasion.
Chairman: Thank you,
and thank you very much, Mr Davies.
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