Select Committee on Treasury Minutes of Evidence

Examination of witnesses (Questions 40 - 59)



  40. In the accounts, and I quote, you said it is unlikely to exceed £50 million in total over the coming months.
  (Mr Sclater) On the basis of the facts and the circumstances as we then knew them, that is what we truly believed to be the case.

  41. That is not what you told the regulator, is it? You warned the regulator of a potential cost of £1.5 billion?
  (Mr Sclater) Can I ask Mr Headdon to comment on this point? There is a very great difference between the statutory accounts of an organisation, which are designed to give a true and fair view to find in a particular way as audited, and the regulatory returns, which are calculated in very different ways. I will ask Mr Headdon to describe exactly how that is.

  42. Before he does that, can I deal with the issue of management here. You revealed to the regulator that there was a potential cost of £1.5 billion but you concealed that from your policyholders and you concealed that from your prospective policyholders.
  (Mr Sclater) I do not think that is fair. The regulatory returns are public knowledge.

  43. You did not tell your policyholders?
  (Mr Headdon) Perhaps I could come in here. The key issue here really comes back to the point I made earlier about how the assets are disposed between the different groups of policyholders. As I said in answer to a previous question, these guarantees had become more valuable and that meant that in some circumstances, even on the bonus system that we were operating from 1994 onwards, policyholders with these polices could receive a higher income than they could buy with their cash fund benefit on open market rates. That meant that those benefits imposed additional cost on the other members. That is a cost that we made provision against but the take-up rate on a whole range of projections was expected to be really quite low because of the differential final bonus system. The regulatory guidance, which came out in January 1999 and applied to the 1998 and 1999 statutory returns, required offices to take a very different approach and assume that there would be a very high rate of take-up and that virtually all policies of this type would take their benefits in the guaranteed income form. Accordingly, we complied with that regulatory guidance and prepared our statutory returns on that basis, but it did not seem to us a realistic view of what the cost to the fund would be in the circumstances of the time.

  44. Mr Sclater, would it not have been more honest to have told the policyholders in the 1999 accounts, which is the document that you send them, that the potential cost was £1.5 billion and not £50 million?
  (Mr Sclater) On the basis of what we understood the most likely legal outcome to be and on the basis of the practice that we were adopting by paying these differential terminal bonuses, it was regarded as extraordinarily unlikely that any cost of that sort would ever arise. Certainly, there was no attempt to conceal anything and those regulatory returns are public knowledge.

  45. How does a policyholder get hold of the regulatory return?
  (Mr Sclater) I am not sure exactly how he does it. He goes and looks it up.
  (Mr Headdon) He can ask for a copy.

Mr Kidney

  46. The historical judgment might be quite cruel about your decision to institute court proceedings and pay for them to get a decision that is your undoing. You tell us that was driven by complaints to the PIA Ombudsman. Had you actually lost any complaints to the Ombudsman?
  (Mr Martin) No, but we saw arising the possibility that he might settle against us one or more cases and that would open the floodgates to more of these complaints. Accordingly, we thought it right to try to get the matter judicially reviewed in order to have a final ruling. So we took that decision in the full knowledge that it was a very serious one for the company but it was better than death by a thousand cuts here and there with lots and lots of these cases arising one by one, all on very different facts.

  47. What is odd is that you saw the possibility of losing the Ombudsman complaint as a reasonable prospect but you saw the prospect of losing the court proceedings as very remote. Why?
  (Mr Martin) I think that is easily answered. Before the Ombudsman it is not as simple to get the whole story before him, but in the court you have an opportunity of testing all the issues very comprehensively, and that is what we tried to do by taking it to the courts. We had a very comprehensive review in all three courts.
  (Mr Headdon) If I may add a comment, there is an important issue here and that is the nature of complaints in late 1998 and the basis for the court action was on the matter of whether a different bonus rate within a policy on the two alternative forms of benefit was legally acceptable. The surprising thing about the House of Lords judgment was that they made an extension of that to say that there had to be commonality of bonus between these policies and other groups of policyholders and even the Court of Appeal had not gone that far.

Mr Beard

  48. Could we look into this question of the House of Lords ruling being such a surprise because it was not really very different from the Court of Appeal's ruling, was it?
  (Mr Martin) Yes, I think it was, Mr Beard, in a variety of ways. First of all, and perhaps for us rather surprisingly, it was not very closely argued. Looking at the House of Lords judgment in front of me and the reports now, I see that the core of it is in 20 lines. In simple terms what the House of Lords said was that we were not to exercise our discretion under the Articles in such a way as to deprive members of a contractual right. That seems to us obvious and perfectly correct; we should not exercise our discretion wrongly. But then, what the House of Lords found, but without any, or any apparent, reason was that it was a policyholder's reasonable expectation amounting effectively to a contractual term that if the current annuity rates fell below the guaranteed annuity rates, then the guaranteed annuity policyholders were to be entitled to the full Monty, if you like, including the final bonus. Now that reasoning is extremely short and very very difficult to comprehend in terms of the sequence of events and the way in which they arrive at PRE becoming a contractual term in these circumstances. That is what has surprised us very much.


  49. You are basically saying you do not think they did the job properly?
  (Mr Martin) I am not saying that, Mr Radice. I am the first to accept that the House of Lords is our final Court of Appeal. It is the final arbiter of the interpretation of contracts of this kind and we must accept it and we do. What I am saying is that the reasoning by which Lord Steyn in particular arrived at this dramatic conclusion, as it has turned out to be for us, is very difficult to follow.

Mr Beard

  50. The Daily Telegraph report immediately after the Court of Appeal ruling, and I quote, stated: "About 90,000 policyholders with Equitable Life may share £1.5 billion after a Court of Appeal ruling yesterday that the insurance company is treating them unlawfully." It said that the Court of Appeal's decision may herald the end of independence for the £30 billion life company. It was a matter of being brought into the public arena in the paper in an article on 22 January. It was a matter of debate, yes. Equitable published accounts in March 2000 which implied that the liability was only £200 million. This was plainly a matter now in the public domain and debated and yet the accounts made no reference to this.
  (Mr Martin) Are you suggesting, Mr Beard, that we should have written our accounts and that they should have been audited on the basis of what The Daily Telegraph wrote or on the basis of the advice of our lawyers and actuaries and the approval of our auditors?

  51. I was suggesting that the issue of whether you might be liable for this extra sum was plainly a matter that was a possibility coming out of the House of Lords. Indeed, last week the Government Actuary when he gave evidence before this Committee said that the Equitable were known for following a practice different from the rest of the life assurance industry. Surely this should have appeared as some sort of contingency in these circumstances? As a result of it not being a contingency, one person who has written to us actually put a substantial amount of money into the funds on 1 June 2000, just before you finally recognised this truth?
  (Mr Headdon) I do think those articles misrepresented the Court of Appeal's decision because, although there was a majority verdict against us, Lord Justice Waller in particular went to some pains to describe that although he felt there could not be a different final bonus between the two forms of benefit, the actual level of that uniform bonus that he felt was legally required could be significantly lower than the bonus that we had been paying on the cash form of benefit. He explained that in some detail. That was the so-called ring-fencing point, that although legally there was a technical difficulty with the differential bonus, the level of share of the funds that the guaranteed annuity rate policyholders in aggregate would be receiving would be not higher than under the previous bonus policy. I think those articles were effectively, I suppose by coincidence, anticipating the House of Lords outcome in that they removed the ring-fencing, but that is not actually what the Court of Appeal said.

  52. At the time this was going on, you were being audited and presumably you had discussions with your auditors on these sorts of assumptions. Were these questions discussed with the auditors?
  (Mr Headdon) Yes, the whole range of advice was discussed with the auditors, but again the actual outcome that the House of Lords eventually arrived at was seen as a remote one.

  53. And the auditors took that view too?
  (Mr Headdon) Yes.

  54. Could we move to another aspect of the question? Why did you believe as a board of the Equitable that there was no need to set aside reserves for other contingencies than your central assumptions?
  (Mr Headdon) The board had always understood that it had a very wide discretion under its Articles to allocate bonuses in a way which gave its policyholders their fair share of the with-profits fund. That has really been a fundamental plank of actuarial thinking and life office management for many years, that the final bonus or terminal bonus, as some offices call it, has a high degree of discretion attached to it and is used in a flexible way to achieve a fair total value of benefits to policyholders.

  55. So you consider these bonuses as a sort of addition to the reserves?
  (Mr Headdon) No.

  56. Or is that based on the bonus?
  (Mr Headdon) No, the final bonus element is discretionary and is deliberately kept in a flexible form, which is not reserved for, so that an office can both retain the investment freedom to invest in equities and things whose value cannot be relied on but which historically have given better overall investment returns to policyholders, but then to distribute the result of those investments at the end of the policy term.


  57. If you had started building up reserves, say from 1993 when the problem first arose, would you then have been in a position after the House of Lords ruling actually to ride it in the way that you have not been able to do?
  (Mr Headdon) Provided we had built up sufficient, yes.

  58. Were you in a position to build up?
  (Mr Headdon) Yes, we could but the way that that would have been done is that we would have built up policy values more slowly over the years so that there was this additional block of assets that was not attributed to any policy values. In a very crude sense, what we would have done is make the reduction in policy values that was implemented in July 2000 gradually over a period of years, rather than making a one-off adjustment at that point in time.

  59. With hindsight, that is probably what you should have done?
  (Mr Headdon) It would clearly have done it in a less dramatic and worrying way.

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