Supplementary memorandum by The Equitable
Life Assurance Society
The Committee raised with The Equitable during
its evidence session the relationship between the statutory reserves
required as part of the regulatory return, and the effect on policyholders'
benefits of the House of Lords' decision. The Committee's concerns
awareness of the nature and extent
of the statutory reserves would have provided policyholders with
an early indication of the potential impact of the most adverse
of a range of possible outcomes from the House of Lords;
the level of the statutory reserves
indicates that insufficient provision was made in the company
accounts for the possible effects of the House of Lords' decision.
There appears to be a fundamental misunderstanding
on this issue, which we feel is important to correct. There is
little or no connection between the statutory reserves and the
impact on policyholder benefits of the House of Lords' decision.
The misunderstanding may arise from the fact that the figure of
£1.5 billion for the statutory reserves (filed in the regulatory
return for the period ending 31 December 1998) is the same as
the amount The Equitable estimated should be set aside to deal
with the consequences of the House of Lords' decision. The fact
that the two figures are the same is coincidental. They deal with
two quite different sets of circumstances.
There are two main elements to the benefits
under with-profits policies. These are (a) the guaranteed benefits
including the annual or reversionary bonus and (b) the final bonus.
The statutory reserves are required to ensure that all life companies
are able to meet their liabilities to pay the guaranteed benefits
in even adverse economic circumstances.
GAR policyholders have the option of taking
their guaranteed benefits in either cash form or as an annuity.
In the latter form, the guaranteed annuity rate is applied to
the guaranteed cash form benefits to produce a guaranteed minimum
The new regulatory guidance that caused us to
set the statutory reserves at £1.5 billion as at 31 December
1998, required us to assume a very high rate of take up amongst
GAR policyholders of the annuity option, in preference to the
cash option. But even under these new assumptions, the statutory
reserves were still only concerned with the guaranteed annuity
benefits produced by applying the guaranteed rate to the guaranteed
cash form benefits. It did not require The Equitable to assume
that the rate should be applied to total benefits including a
final bonus or, indeed, to anticipate a final bonus at all.
For the statutory reserves to be fully called
upon would have required there to be not just a significantly
adverse set of conditions, but for these conditions to prevail
throughout the whole period during which retirement benefits would
be drawn. As this was considered unlikely to apply, it was possible
for The Equitable to transfer some of the risk via a reassurance
policy. The statutory reserves are not, and were never intended
to be, a means for providing for the consequences of the eventual
decision of the House of Lords.
The litigation on which The Equitable embarked
was designed to establish if it was lawful to pay different final
bonuses to GAR policyholders depending on whether or not those
holders exercised the right to take their benefits in annuity
form at a rate guaranteed by the Society. It related therefore
to the treatment of final bonuses, not the guaranteed benefits
with which the statutory reserves are concerned.
The Court of Appeal determined by a majority
of 2:1 that it was not lawful to differentiate in this way within
the group of GAR holders. A GAR policyholder should receive the
same proportionate final bonus irrespective of the form of benefits
selected. The Court did not however rule that the society could
not differentiate between GAR and non-GAR holders in this respect.
The House of Lords' ruling took matters one
stage beyond this by saying that the Society could not apply a
different bonus policy to GAR and non-GAR holders.
The effect of this ruling was to bring about
an economic transfer from non-GAR holders to GAR holders. The
with-profits fund is a single pot of money. The House of Lords'
judgment affects the way in which the assets in the fund are allocated
between different categories of policyholder. Following the House
of Lords' decision, this necessary reallocation of assets was
assessed at £1.5 billion. The Society could have in theory
anticipated the House of Lords' decision earlier and started to
make the reallocation sooner. This would have influenced the phasing
of the economic transfer, but would not have changed the result.
In light of this fact, the legal advice that suggested such a
decision was a remote possibility, and the Society's objectiveas
a mutualto allocate assets fairly between different groups
of its members, the action taken at the time was thought to be
The House of Lords' ruling did not, and has
not since, determined the level of The Equitable's statutory reserves.
We would still have had to continue to make provision for additional
statutory reserves as we did at the end of 1998 and 1999, even
if the House of Lords' decision had not gone against us.
A distinction needs to be made between two forms
of guarantee and between two forms of reserving.
There are the "guaranteed benefits"
that apply to all with-profits policyholders and there is the
"guaranteed annuity rate" that applies to GAR policyholders
choosing to take their benefits in annuity form.
There are the statutory reserves designed to
provide a contingency against falls in asset values, to an extent
that the Society would otherwise become unable to meet its liabilities
to pay guaranteed benefits when a with-profits policy matures.
There is also the separate provision that the Society has had
to make to set aside a greater proportion of assets from within
the single with-profits fund to re-allocate from non-GAR holders
to GAR holders. It is only the latter which was directly affected
by the House of Lords' judgment.
19 March 2001