APPENDICES TO THE MINUTES OF EVIDENCE
Memorandum by the Annuity Bureau Ltd
"To examine the regulatory environment and
the management of risk in the life assurance sector following
the Equitable Life affair"
(This memorandum has been prepared by David
Marlow of The Annuity Bureau for the Treasury Committee investigation.)
1. THE ANNUITY
1.1 The Annuity Bureau, together with its
associated company, The Income Drawdown Advisory Bureau, is a
specialist Independent Financial Adviser company focused on the
provision of retirement advice.
1.2 The Annuity Bureau concentrates on annuity
business, providing services to those with Open Market Options
and those wanting to provide income from non-pension funds. The
Income Drawdown Advisory Bureau concentrates on Phased Retirement
and Income Drawdown pension arrangements.
1.3 The Annuity Bureau was established in
1990 and both companies are directly regulated by the Personal
1.4 The specialism of our companies means
we understand the issues surrounding the Guaranteed Annuity Rate
contracts offered by Equitable Life. We are a small firm of approximately
30 staff, but we have a broad spread of industry experience and
2.1 Some pension contracts provided the
right to a guaranteed annuity rate (GAR), ie a guaranteed rate
at which the capital value of a pension contract could be converted
into income, via an annuity.
2.2 The guarantees on these contracts extend
many years into the future.
2.3 The cost of providing these guarantees
varies, depending on three key variables:
(a) Investment performance. The capital value
to be applied to the GAR depends on the investment performance
during the term to retirement age. (Some contracts applied the
GAR to a known value, thereby removing this variable);
(b) the "normal" annuity rates
applying at the maturity date of each contract. At times when
the normal rates available from the provider are as high as or
higher than the GAR, the GAR costs nothing. But, in times when
rates available are lower than the GAR, the cost is relative to
the difference of the two. In practice, through the use of open
market options, the guarantees may not cost anything providing
a higher rate is available on the open market;
Annex 1 highlights this point. Based on estimated
figures, it shows that the GARs provided by Equitable Life started
to become valuable to annuitants (ie started to cost Equitable
Life something) during 1993. Clearly, if the OMO amount of income
falls further in future, so does the cost of providing GARs; and
(c) the number of people exercising their
right to a GAR. High take-up is likely when the rate is attractive,
but, as the GAR only applies to annuities bought on a particular
basis, it is not suitable for all retirees. However, even in these
instances, it is usually beneficial for the retiree to exercise
their GAR on at least part of their pension fund.
2.4 So, providers of such contracts carry
a risk, the exact extent of which is unknown.
2.5 This risk is usually managed by setting
reserves aside to meet the potential costs and or reassuring part
of the expected liabilities.
2.6 This risk is similar to that inherent
in Final Salary pension schemes, whereby the employer is taking
the risk. Here, instead of investment performance being a variable
factor on the future value of the liabilities, it is the projected
growth in salaries. (Good investment performance in this instance
benefiting the employer through potentially lower contributions
to the scheme.) This similarity is mentioned as the ongoing debate
around the Minimum Funding Requirements for such schemes could
provide some further insights to the issues associated with Equitable
Pensions with GARs were sold in large volume.
The company chose to distribute high levels
of with profit fund returns, thus leading to a low free asset
ratio, ie insufficient reserves were set aside to meet the liabilities
arising from GAR policies.
3.1 Whether such factors could affect other
Yes, as the same factors affect other companies
who sold GAR pensions. But, the scale of the problem is unlikely
to be repeated as other companies have generally been more conservative
in the distribution of with profit fund returns, ie they have
3.2 Consequences for investor confidence
Bad. The Equitable life's closure to new business,
their withholding of bonuses to some members, the increased Financial
Adjustment of 10 per cent to those transferring and the company's
perceived or actual arrogance (demonstrated by their continuing
to actively promote themselves after the High Court ruling) have
all contributed to lower investor confidence.
Many will no doubt feel that similar mismanagement
could apply to other companies, regardless of the facts of this.
3.3 Role of the regulators
Regulatory monitoring should ensure that companies
have adequate risk management controls (in particular, prudent
Regulatory monitoring should ensure that companies
cannot trade when their own stability is in doubt.
Clearly, both these safeguards have not happened
in relation to the Equitable Life.
Whilst we do not believe there is a simple solution
to ensure that this damaging affair cannot re-occur, we mention
below aspects of concern for consideration. Overriding any concerns
listed is the need to protect consumers and to ensure that the
necessary incentives for people to save for their own retirement
are not damaged further.
3.4.1 The current wide discretionary powers
of Appointed Actuaries.
3.4.2 Lack of true transparency in contract
3.4.3 The inequality of corporate governance
requirements between mutual and proprietary companies.
3.4.4 The lack of accounting monitoring
(which allowed the company to promote financial strength, based
on flawed assumptions. Namely, that it would win the court case).
2 February 2001