Select Committee on Treasury Minutes of Evidence


Examination of witnesses (Questions 1 - 19)

THURSDAY 15 FEBRUARY 2001

MR JOHN SCLATER, CVO, MR PETER MARTIN AND MR CHRIS HEADDON

Chairman

  1. As you know, the Treasury Committee is holding an inquiry with the following terms of reference: to examine the regulatory environment and the management of risk in the life assurance sector, following the Equitable Life affair. Of course, there are three other inquiries going on but this is the first to be held in public and it is being carried out by the representatives of the people. I am sorry that this room is so large. I think, Mr Sclater, you want to make an initial statement.

  (Mr Sclater) Mr Chairman, briefly, may I introduce myself? I am the Chairman of the Board of the Equitable; on my right is Peter Martin, who is Vice Chairman and a lawyer by profession; on my left is Chris Headdon, who is the Chief Executive, recently appointed, previously the appointed actuary. I would like to say, first of all—I have said this before and I will repeat it—that we are profoundly sorry for what has happened at the Equitable. We deeply regret it. I am conscious of the fact that it touches the lives of very many people and I could not be more sorry about that. In recent months, we have focused our energies on trying to realise as much value as we can for the Society and for the members. In that context, I am very pleased that we have sold successfully The Permanent Insurance Company for £150 million and we have now concluded a deal with the Halifax which, all being well, should produce another £1 billion for the members. The most important task now is to secure a compromise between those who do and those who do not have guaranteed annuities in their policies. In that context, I am very pleased that it was possible yesterday for the Society to announce that Mr Vanni Treves will take over shortly from me as Chairman and I am sure that he and the new board will do their very best to take things forward in a good way.

  2. Thank you. Could I start with two general questions? Why did the crisis in the Equitable happen and what does the future hold for the Equitable policyholders, following the deal with Halifax Bank?
  (Mr Sclater) In terms of why the crisis happened, I think there was a series of probably unique circumstances that combined together to produce what eventually happened, and I would like to ask Mr Headdon to elaborate on those, if I may.
  (Mr Headdon) This issue has essentially been about how the assets of a mutual organisation are divided up between the different groups of members. The board followed an approach which they believed was fairly attributing the assets in a particular way. The House of Lords decision rendered that approach inappropriate and the assets had to be divided up in a different way, which produced more of the assets going to the guaranteed annuity rate policyholders and less to the remainder. The reason why it had a particular effect on the Equitable Life is really due to three factors. Firstly, over the years we have been predominantly a pensions office, so we have a larger proportion of this sort of business in our portfolio than many other offices. Secondly, we offered a very flexible type of contract and a guarantee that applied at a wide range of ages, not just at one specific retirement age chosen at the outset. In that sense, it was a more widely applicable guarantee than had been the case for other organisations. Thirdly, as a mutual, we had a well-known policy of trying to distribute earnings as fully to members over the years as we possibly could. Consequently, we had no shareholders' funds and no, what are commonly called, orphan assets in order to meet this unexpected liability that arose from the House of Lords decision. As for the future, as Mr Sclater said in his introductory remarks, the focus since July has been on trying to achieve the best possible future for members, and a number of steps have been put in place in recent months. When the Halifax transaction becomes fully effective, I believe we will have secured a considerable new cash injection into the fund. The compromise between the guaranteed and non-guaranteed rate policyholders, which is an intrinsic part of the deal, will strengthen the fund in the financial sense and give greater investment freedom going forward. The deal has also secured cost-effective administration for the members on an ongoing basis and access to a first-class investment team. I think those measures taken together should lead to a considerably better future after the period of uncertainty that we have seen over recent months.

  3. We will be looking later at the deal. The way you have described what happened is that it is a sort of process of events which you could not really have been expected to do anything about. Am I right in describing the way you have just explained your case?
  (Mr Headdon) I do not think I would put it in quite that way. Clearly there has been a succession of events over the years.

  4. Do you think mistakes have been made?
  (Mr Headdon) Clearly, with hindsight, one would have done some things differently.

  5. What?
  (Mr Headdon) In the 1980s the board looked ahead to the prospect of an environment of much lower interest rates than had been experienced during the 1970s and 1980s when these policies were being sold. The course of action that was determined to cope with that was to have a different final bonus rate to reflect the different value of the guarantees on the policy. That was consistent with the type of bonus approach that we have described to our members. It was consistent with normal actuarial practice, where one has different bonus levels where contracts contain different guarantees. When those circumstances actually emerged at the end of 1993, that was the approach that was then implemented. Clearly, one mistake was that we did not do enough at that time to make members aware of that bonus system and the rationale for it. We thought that we had but in 1998 it clearly emerged that some members were not content and therefore, by definition, we had failed to explain the rationale for the approach and the reasons for it properly in the early 1990s.

  6. So that was your only mistake?
  (Mr Headdon) I think that was a significant mistake. It is the result of a whole chain of history. With hindsight, one can pick out individual things where anyone would wish that a different course of action had been taken. If one goes right back to the beginning, one might say that perhaps it would have been better if the policies had not been sold in the first place. It is a combination of circumstances. It is quite difficult to isolate one particular event and say that was a key turning point.

  7. Did you expect the House of Lords decision?
  (Mr Headdon) No, we did not.

  8. That is another possible mistake?
  (Mr Headdon) We had certainly planned for the possibility of it arising but, on all the advice that we had been given, we considered it to be a very remote possibility.

  9. That is why you did not take enough precautions to guard yourselves against a decision which you thought was unlikely. Is that right?
  (Mr Headdon) I think that is a very interesting question because, from the vantage point of 1998, the question is: what could have been done? As I said earlier, this whole case is essentially about how the funds of the Society are divided up between different classes of members. Really, the only thing one could have done in 1998 to anticipate the House of Lords outcome was to make the change in bonuses between the different groups of policyholders, which was in fact implemented in July 2000, at an earlier date. That would have been a very curious course of action because, firstly, it would have been effectively anticipating what was thought to be a very unlikely outcome; and, secondly, we were embarked on a course of action designed to confirm the correctness and fairness of the approach that was being taken. It would have been extremely odd then simultaneously to have implemented a completely different bonus system that was inconsistent with that.

Sir Michael Spicer

  10. I need to declare first that my wife is an Equitable Life policyholder. The question I want to ask is: is there any possibility, however remote, of Equitable Life now going bust?
  (Mr Sclater) The Equitable is solvent and has always been solvent. I am not an actuary but I think I am correct in saying that if interest rates were to fall sufficiently and if equities were also to fall in value greatly, in other words you had an unusual set of circumstances in the market where equities were collapsing while gilt yields were falling, I think I am correct in saying that under those circumstances, it would, in an extreme case, be possible for the liabilities to exceed the assets. Can I ask my friend, who is an actuary, to confirm whether I have got that right?
  (Mr Headdon) I think there is an important distinction to be drawn here between true insolvency, which I take "going bust" to mean in the sense of being unable to meet the guaranteed liabilities, and technical insolvency under the insurance company regulations, where those regulations contain a number of layers of protection to cope with really a quite significant variation in economic circumstances. In many ways that gives an early-warning system that one may be moving on a path towards true insolvency, but technical insolvency in the sense of being unable to meet the statutory solvency margin laid down in regulations typically happens at a much earlier stage.

  11. If we take two examples in a moment, would that not occur perhaps if there was to be a run, for instance, of with-profits policyholders from the company?
  (Mr Headdon) That should not happen because these are long-term contracts and a run normally implies that people are terminating contracts early and life offices typically have some control over the level of values that they pay in those circumstances. Those values will be set in a way that protects the interests of the continuing members of the fund.

  12. You are saying that the penalties would be sufficient in your view to prevent people leaving the fund?
  (Mr Headdon) I believe all life offices normally have enough freedom to set surrender terms such that those surrendering do not damage the interests of the continuing policyholders.

  13. But it might be the case that people were willing to pay the penalties to leave?
  (Mr Headdon) Yes, but if the values they take away do not leave the people who stay behind in a worse position, that is a financially neutral position for continuing policyholders.

  14. You are confident that in a true sense there will not be disintegration?
  (Mr Headdon) I think it is a very remote possibility, as it is for all life companies.

  15. One of the things which no doubt my colleagues will be exploring later is the question of your fallibility on these matters. You got the £1.5 billion wrong and you got the reserves associated with that wrong: might you not be getting these answers wrong in respect of insolvency?
  (Mr Headdon) To the extent that the regulatory system provides a standard framework for life offices to report their positions, we are fully compliant with the regulations and guidance that goes around that, and are maintaining the statutory margin of solvency.

Mr Kidney

  16. I do not have any policies with Equitable Life. To check the basic facts, typically people talk about 90,000 holders of the guaranteed annuity rates policies and 370,000 or so with profits non-GAR policyholders and some of those groups schemes with over one million people affected. Are those statistics correct?
  (Mr Headdon) Broadly, yes.

  17. As far as your policy of distributing the full asset share and not maintaining great reserves that can cover all the funds for the future, would you describe your company as unique in doing it that way?
  (Mr Headdon) I am not sure "unique" would be correct but I think we were probably fairly unusual in running such a distribution policy, yes.

  18. In that specific respect, the Faculty of Actuaries, who have written to us, say that Equitable Life Assurance Company was unusual, some would say unique, in the way it conducted its financial affairs. How many more companies do you know that distributed as fully as you do?
  (Mr Headdon) I think that is difficult to answer because companies typically do not broadcast the level of their orphan assets around the industry, unless the company has set out in its public documents what its distribution philosophy is. We were probably fairly unusual in doing that through the Eighties and Nineties. It is actually difficult to tell from other offices' statements quite what their distribution policy is.

  19. I will come back to that in a moment. The end of the GAR policies was 1988, so that is nothing to do with worries about future liabilities but it is to do with changes in the tax regime and new policy developments. Is that correct?
  (Mr Headdon) It was mainly driven by the introduction of the personal pensions legislation, which was much more focused on building up a cash fund benefit and they were called portable pensions. The idea was that you accumulated a fund of money which you took around from job to job and then bought a pension with that at the time you retired. So the whole ethos of that contract was on a cash-orientated product. It seemed a natural point to us to stop selling contracts that provided a guaranteed minimum level of income.


 
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