Examination of witnesses (Questions 40
THURSDAY 15 FEBRUARY 2001
SCLATER, CVO, MR
40. In the accounts, and I quote, you said it
is unlikely to exceed £50 million in total over the coming
(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
41. That is not what you told the regulator,
is it? You warned the regulator of a potential cost of £1.5
(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
(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
(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.
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
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.
(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.
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
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.
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
(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,
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.