Select Committee on Treasury Sixth Special Report


Appendix

LETTER TO THE CHAIRMAN OF THE COMMITTEE FROM THE ECONOMIC SECRETARY TO THE TREASURY, RUTH KELLY MP

I wrote to the Committee on 31 August with an interim response to the Interim Report into Equitable Life and the Life Assurance Industry.[2]

The Government is grateful for the work of the Treasury Select Committee in producing the Interim Report into Equitable Life and the life assurance industry. The Government has noted the recommendations made in this report.

This letter and attachment provide the full Government response to that report.

GOVERNMENT RESPONSE TO THE TREASURY COMMITTEE'S TENTH REPORT, SESSION 2000-01: EQUITABLE LIFE AND THE LIFE ASSURANCE INDUSTRY: AN INTERIM REPORT

It is clear that the situation at Equitable Life raises important issues for the conduct, administration and regulation of the life assurance industry. As explained in the memorandum by HM Treasury to the Committee, the Government is responsible for the legislative framework of regulation. The FSA is responsible for regulation, both in terms of prudential supervision and conduct of business regulation. Until the implementation of the provisions of the Financial Services and Markets Act, this is under interim arrangements which have been designed to create the benefits of the new regime as far as possible under existing legislation.

In the past, the Department of Trade and Industry, and, in 1998, HM Treasury were directly responsible for the prudential supervision of insurance companies while the relevant self regulatory organisations (first the Life Assurance and Unit Trust Regulatory Organisation, then the Personal Investment Authority) were responsible for the conduct of business regulation of life business.

I wrote to the Committee on 31 August regarding the Government announcement of an independent inquiry into Equitable Life. The terms of reference for the Inquiry, to be conducted by Lord Penrose, are:

    To enquire into the circumstances leading to the current situation of the Equitable Life Assurance Society, taking account of relevant life market background; identify any lessons to be learnt for the conduct, administration and regulation of life assurance business; and to give a report thereon to Treasury Ministers.

In addition, the FSA have conducted an internal review of the discharge by the FSA and the Personal Investment Authority of their regulatory functions in relation to Equitable Life in the period from January 1999 to December 2000. The Government is grateful to the FSA for the work which has gone into completing the review. The report of the review was passed to the Government last week and has been presented to Parliament today.[3]

In line with its terms of reference, the report analyses conduct of business and prudential supervision over this short period. The report is a helpful contribution to understanding aspects of the Equitable story. I have today passed a copy of the report to Lord Penrose as evidence to the Inquiry he is conducting into the circumstances leading to the current situation at Equitable Life.

By its very nature, the report deals with only two years out of a story which covers more than forty years in total. It could not, as it acknowledges, deal with the actions of other key players; in particular, it could not look at the internal decision making and actions of the most important of all, namely Equitable Life itself over the decades. The report is therefore a significant but necessarily limited part of a much larger picture of events relating to Equitable Life.

By virtue of its wide ranging remit, the Inquiry to be conducted by Lord Penrose into the current situation at Equitable Life will be able to look back as far as necessary to the origin and development of the problems and look in detail at the actions of the Society and all of the other key players.

While Lord Penrose cannot be bound by either the analysis or the conclusions and recommendations of the FSA report, the Government understands he expects it to be an important piece of evidence to his independent Inquiry.

The FSA report makes a number of detailed recommendations about the regulation of life insurance, in particular its call for improved solvency and disclosure standards.

Some of these recommendations will involve consultation with the industry and the Government is anxious that the FSA should take this forward as a matter of urgency. The conclusions of this consultation will, of course, need to be considered alongside the work of Lord Penrose's independent Inquiry, but the Government hopes the FSA can start this work immediately.

The report also makes a number of recommendations on the 'regulatory approach' - the FSA's culture, processes and tools - to ensure that it achieves the "role, style and approach" envisaged for the FSA as a single, integrated regulator. The Government believes that implementation of these recommendations is crucial to the delivery of an integrated risk based regulator and to the objective underlying the creation of the FSA. The Government has therefore asked the FSA to provide a report by 20 November, prior to the time at which it adopts its full powers, covering the actions they have taken, or plan to take, to implement these recommendations.

The Government Actuary's Department have also been involved in discussions on the report. Action has already been taken to address the issues raised in the FSA report and actuaries covering the insurance sector are now integrated fully into the FSA.

In addition, as the Committee is aware, the Government is making major changes to the structure of financial services regulation in the UK. As part of the implementation of the Financial Services and Markets Act 2000, the Government is issuing today a consultation paper, together with draft regulations, on the circumstances in which appointed actuaries will be obliged to inform the FSA of matters that have come to their attention during the course of their duties.

GOVERNMENT RESPONSE TO INDIVIDUAL RECOMMENDATIONS

(a) We would like the Financial Services Authority (FSA), Faculty and Institute of Actuaries (F&IA) and Institute of Chartered Accountants of England and Wales (ICAEW) to take on board the points we make in this report in the context of their own inquiries, so that the Equitable Life Affair can be properly and fully explained and to help the Committee continue the investigation (paragraph 5).

The Government notes this recommendation. These reviews are the responsibility of the organisations conducting them. However, the Government welcomes the work that the F&IA and ICAEW have undertaken. As the Committee will be aware, the report of the inquiry undertaken by the F&IA, the Corley Committee of Inquiry, was published on Friday 28 September. The Corley Committee made clear in their report that they took account of the comments made by the Select Committee.

The ICAEW inquiry is continuing. The Government understands that they are considering the Treasury Committee's interim report in the context of their own disciplinary process and that they have read the Actuary's report with interest.

(c) The F&IA report should consider whether the actuarial guidance provided by the F&IA was appropriate at the time, and whether such general advice was suitable. It should also consider the extent to which the F&IA's opinion was based on the prudential insurance regulator's view (paragraph 17).

The F&IA report was published on 28 September. The report made clear that, in as far as relevant to its terms of reference, the inquiry took account of the comments made by the Select Committee.

(e) The relationship between firms' Appointed Actuaries and management boards, and with the body of policyholders, is in need of review, in the light of the Equitable Life affair (paragraph 20).

The Government notes this recommendation. As the Committee is aware, the Government is making major changes to the structure of financial services regulation in the UK. The Committee may be interested to know that as part of the implementation of the Financial Services and Markets Act 2000, the Government issued a consultation paper and draft regulations on 17 October 2001 covering the circumstances in which appointed actuaries will be obliged to inform the FSA of matters that have come to their attention during the course of their duties.

In addition, one of the recommendations in the report of the FSA review is that appointed actuaries should be subject to external review. This is on the basis that reliance on an individual with no external or detailed check, inevitably poses risks. Action has already been taken to integrate actuaries covering the insurance sector into the FSA. It is possible that the role of the appointed actuary may also be the subject of review and recommendation by Lord Penrose. The Government has asked the FSA to ensure that the outcome of their work is integrated with that of the Penrose Inquiry.

(f) It is unclear to us why the issue of GAR liabilities and reserving was not considered by the prudential insurance regulator at least by 1993, rather than only in 1998. We believe that the current inquiries should pursue this closely (paragraph 21).

These reviews are the responsibility of the organisations conducting them. However, the Government welcomes the work that the FSA, the F&IA and ICAEW have undertaken, and are, in the case of the ICAEW, still undertaking.

The terms of reference of the Penrose Inquiry will allow Lord Penrose to pursue this issue.

(g) We ask the FSA to consider whether cash reserves only need to be accumulated when required by the economic circumstances—or whether there are other circumstances in which cash reserves may be required (paragraph 26).

The issue of the prudential framework was considered by the FSA review which recommended that the current framework needs to be restructured so that the required minimum capital reflects all the risks in the business. The FSA will take this recommendation forward.

The terms of reference of the Penrose Inquiry will allow Lord Penrose to pursue this issue further. The Government has asked the FSA to ensure that the outcome of this work is integrated with that of the Penrose Inquiry.

(h) We ask the FSA to reconsider whether it was right to accept the reinsurance contract given its terms, and whether it was prudent to allow such a contract to have accounted for half of the Equitable Life's statutory reserves (paragraph 28).

The issue of acceptance of the reinsurance contract was considered by the FSA review. The report notes that Equitable Life did not disclose the full terms of its reinsurance contract. The report goes on to recommend the full disclosure of financial reinsurance arrangements. The FSA will consult urgently on the implementation of this recommendation.

This area is one which is open to Lord Penrose to pursue as part of his independent Inquiry into Equitable Life. The Government has asked the FSA to ensure that the outcome of this work is integrated with that of the Penrose Inquiry.

(i) Equitable Life demonstrated that the information provided to policyholders, through the statutory accounts, and to the regulator, through the regulatory return, differed substantially in their treatment of the GAR liabilities and the consequential reserving that had been undertaken. As a result, policyholders were not able easily to establish the true position of the company. We ask both the FSA and the ICAEW to consider whether statutory accounts and regulatory returns should draw upon the same information and assumptions wherever possible, in order to improve transparency. In addition, the FSA should consider whether a life office's reserving policy should be made clear to policyholders, either in statutory accounts or in some other way (paragraph 31).

(j) We do not believe that the auditing arrangements for the statutory accounts and, in particular, the regulatory returns of life offices were adequate. In their memorandum to us, Ernst and Young set out the judgments that they made concerning disclosure. We ask the FSA to consider the justification for the auditors' judgments and whether there are implications for future reporting practices by auditors generally (paragraph 32).

The Government notes these recommendations. The FSA review considered the framework of the regulatory returns required from life offices and made a number of recommendations regarding both content and format. The FSA are taking forward these recommendations.

(k) Equitable Life failed to explain to their policyholders the full implication of Lord Woolf's judgment. The FSA should therefore consider whether the assessment made by Equitable Life, and indeed by themselves, of whether the eventual House of Lords ruling could have been predicted, was justified, especially given Lord Woolf's judgment (paragraph 37).

The FSA review considered the early assessment made by the regulator of the potential outcome prior to the judgement of the House of Lords. The report of the review concluded that the regulator should have placed less reliance on statements made by Equitable Life and should have prepared an alternative plan of action. It goes on to conclude that if the regulator had done this, it would have been in a better position to act when the judgement was made. The report recommends a more pro-active approach by the FSA. The Government has asked the FSA to pursue this recommendation vigorously and to provide a full report, by 20 November, covering the action the FSA Board has taken, and intend to take, to implement it.

(l) We welcome the FSA's review of Equitable Life's selling practices after the Court of Appeal decision and we ask the FSA to review the Equitable Life's practices when pension policyholders gave up rights to guaranteed annuity rates (paragraph 42).

The Government notes this recommendation. Any review of the practices of Equitable Life when pension policyholders gave up rights to guaranteed annuity rates is a primarily a matter for the FSA. However, this area is one which is open to Lord Penrose to pursue as part of his independent Inquiry into Equitable Life.

(m) We welcome the announcement of an FSA review of management discretion in the with-profits business. We recommend that the FSA analyse the extent to which financial services, in particular life assurance, rely on managerial absolute discretion (paragraph 46).

The extent of discretion available to managers of with-profits funds, and how that discretion is exercised, are issues which are being addressed by the FSA's review of with-profits business. In addition, these sorts of issues will be addressed more widely by the Sandler review of retail investment.

The Sandler review was announced in the Government's statement "Enterprise for all - the challenge for the next Parliament" on 18 June 2001. Its terms of reference, for the markets for long-term retail savings, were:

    "to identify the competitive forces and incentives that drive the industries concerned, in particular in relation to their approaches to investment, and, where necessary, to suggest policy responses to ensure that consumers are well served".

(n) It is important that the role of regulator since 1993, when Equitable Life began to operate a policy of terminal bonus differentiation, should be analysed in order for the regulatory lessons to be properly learnt for policyholders to fully understand the history of the affair and for Parliament to undertake its scrutiny of this topic properly and fully. The Committee will await the FSA's report. It will want to examine what it has to say on the regulatory background to the Equitable Life affair between 1993 and 1999, and then decide how to proceed (paragraph 50).

As the Committee is aware, the Government has announced an independent inquiry into Equitable. The Inquiry, headed by Lord Penrose, will be free to look at past events as necessary. In the same way, Lord Penrose will also be able to look at more recent events.

(o) We welcome the announcement that the FSA inquiry will have access to Government Actuary's Department (GAD) files and personnel. In our recent report on GAD, we recommended that GAD should publish a regular report to Parliament on the life assurance sector, so that public attention can be drawn to trends and issues of concern. We recommend that the FSA inquiry make suggestions as to how this could best be achieved and how better public information about the condition of individual life assurers can be published, on the basis of the actuarial advice received by the FSA (paragraph 53).

The Government notes this recommendation. The recommendations made by the FSA review are a matter for the FSA review team. However, the Committee will note that GAD actuaries dealing with life assurance have now been integrated within the FSA. Under the Financial Services and Markets Act 2000, one of the responsibilities of the FSA is to make reports to the Treasury at least once a year on the discharge of its functions. These reports will cover the FSA's responsibilities in connection with the life assurance industry and will be laid before Parliament.

This issue was considered by the FSA review which recommended that the FSA consider the feasibility of producing, on a regular basis, a review of issues and trends that may pose a regulatory risk to the industry. The FSA will take forward this recommendation.

HM Treasury
October 2001


2  
Not reported. Back

3  Report of the Financial Services Authority on the Review of the Regulation of the Equitable Life Assurance Society from 1 January 1999 to 8 December 2000, which Her Majesty's Government is Submitting as Evidence to the Inquiry Conducted by Lord Penrose, HC (2001-02) 244. Back


 
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