Select Committee on Treasury Minutes of Evidence

Examination of Witnesses (Questions 1-19)




  1. Good morning, Sir Howard. Welcome again to the Committee on this hearing on the regulation of Equitable Life. For the sake of the shorthand writer would you introduce yourselves, please?
  (Sir Howard Davies) Howard Davies, Chairman of the Financial Services Authority, and John Tiner, Managing Director responsible for consumer affairs, investment and insurance.

  2. Thank you. Sir Howard, as Chairman of the FSA Board, did you in any way attempt to modify or change the Baird Report before it passed to the Treasury?
  (Sir Howard Davies) The first six chapters are entirely as written by the team without any involvement from management or from the Board. Chapter 7, which contains the recommendations for future action, was shown to a non executive committee of the FSA Board in draft because the team thought that the recommendations were in some way a different character from the analysis. We made one or two minor comments on the recommendations but not such as to change them in any substantial way.

  3. The Baird Report did not cover the issues after 8 December 2000. What consideration have you given to these issues?
  (Sir Howard Davies) We have been continuing with our regulation of Equitable Life, of course in the unusual circumstances as it is a closed fund and one seeking to reconstruct itself through a compromise scheme. We obviously saw for maxwellisation purposes the recommendations two or three months ago and we have been taking into account those recommendations in our continuing work.

  4. Are you satisfied now that the steps you are taking in regard to life assurance regulation will be sufficient?
  (Sir Howard Davies) If I could divide that into two, Chairman. One are the internal steps and two are the external steps because the recommendations really fall into those two categories, the things which are about how the Authority is organised in order to manage the regulation of the life insurance sector and the regulatory environment within which we operate, by which I mean the rules, the role of the appointed actuary, etc.. On the former, the Board has taken a close interest in the way in which we have responded. I would say that as far as the management structure of the Authority is concerned, we had in fact already made the changes indicated by this report and, indeed, we had declared our intention of doing so over 18 months ago, that we would bring together the prudential and conduct of business regulation ready for N2 when we took on our full responsibilities. So those management restructurings have been undertaken. They were finalised, fully completed on 1 April this year. The problems to which the report draws attention in terms of communication between different types of regulators in the ancestral regime, if you like, all of that has been dealt with in a structural way and the Board is satisfied that it has been. The second set of recommendations obviously relate to the way in which life insurance companies report their assets and liabilities, the role of the appointed actuary, etc. Those recommendations are now being carried forward by a team headed by John Tiner, which is why he is here today, with a team of a dozen or so people drawn partly from outsiders, from consulting firms and others, and partly from people seconded from other parts of the FSA into that team and that work is now under way. Of course that work requires consultation with the industry and will require cost benefit analysis etc, subject to the disciplines of the Financial Services and Markets Act.

  5. You did appear in the Money Programme on 20 October and mentioned to the nation that you had reduced your salary by £13,900. Subsequent to that in a discussion—and I have looked at the transcript—the interviewer was pressing you on why the salary reduction took place and trying to find out if there was any culpability there on your part. It does seem to one on the outside if you are losing £13,900 there has to be some reason for that personally. I notice in the transcript when you were asked directly if you had taken your eye off the ball you said "No, I have not taken my eye off the ball". What you are saying is in effect you did nothing wrong. If you did nothing wrong, it puzzles me why you have lost £13,900?
  (Sir Howard Davies) Perhaps I could explain the way in which senior executive remuneration at the Authority is determined. There is a Committee of Non Executive Directors chaired by the Deputy Chairman, which is our remuneration committee. That remuneration committee has set a basis on which the remuneration of the senior executives of the Authority should be determined. That divides between the basic salary and a performance related bonus. In relation to the basic salary the remuneration committee takes advice from salary consultants about movements in the external market using a range of comparators from other city organisations and other regulatory organisations. In relation to the bonus entitlement of the executive members of the Board, the Committee established a procedure for determining how much bonus the executives should be entitled to which takes account of, first of all, objective criteria, for example meeting the budget during that year, meeting for example the service level agreements that we had in terms of the programme, and there are various other measures to do with the speed with which we authorise firms, etc. There are a whole series of objective measures to do with the running of the Authority. The remuneration committee also consults the chair of the consumer panel, the chair of the practitioner panel and the Treasury about their impressions of how well the Authority is operating and delivering its strategic objectives and also the reputation of the Authority. They then take account of all of those factors and reach a determination on how well they think the senior executives have performed against these objective factors but also on these reputational factors. They concluded in the light of that analysis that they would pay a lower bonus in respect of the year 2000 than in respect of the year 1999, I think partly because they considered that there had been reputational damage to the Authority. They did not have the report in front of them, this decision was made some months ago, quite unrelated to the Baird Report. The decision was made in January of this year so the two points were completely unrelated, as it were, the assessment in the Baird Report and the assessment of the decision. I feel somewhat uncomfortable in going into detail about this, Chairman, because I am not responsible for my own remuneration, that is done by the non-executives.

  6. I understand. From our point of view, we are interested in the issue of culpability. We are looking here to see if anyone was responsible for the situation in Equitable Life. In your own case you were at a meeting on 5th December 1998 in the Treasury and in the Baird Report—and I refer to the Baird Report—4.19.2 mentions a briefing memorandum. It would appear from the Baird Report you had prior warning of the potential prudential problems at the Society and the fact that this was the only insurance company whose problems were the subject of a specific pre handover note issued on 15th November 1998 by the Treasury to the FSA might have raised alarms with you regarding Equitable Life.
  (Sir Howard Davies) It certainly did and Equitable Life received a disproportionate amount, well disproportionate is the wrong word, received an unusual amount of senior management attention in relation to other insurance companies during the subsequent period. I would point out that that meeting predated the Equitable's decision to go to court to seek to resolve its bonus issue and, therefore, the position relating to the company and the relationship that we had with it and the flexibility that regulators had to deal with it changed very substantially immediately after that meeting. The Equitable decided to go to court without consulting or informing the regulators and from that point on there was a court process which led to the House of Lords' decision which has been at the root of the company's difficulties. Things changed very quickly after that meeting. I would say certainly that we were aware of the problems in Equitable Life and you will see from the report that there were extensive exchanges with the company, particularly on the question of reserving for guaranteed annuities and we pursued, as the report says, a resolute approach to getting the company to increase its reserving.

  7. If I could go through the Baird Report and pick out one or two issues. For example, the failure to integrate adequately the prudential regulation of insurance with the conduct of business insurance regulation, paragraph 6.23.4, and that is relating to FSA representatives. A failure to follow up some of the issues which arose from earlier regulatory interventions including, for example, requiring proper disclosure in the regulatory returns of non contingent risks in terms of key financial re-insurers or the risk of a legal challenge to Equitable's bonus policy, paragraph 6.8.2. A failure by the FSA to enquire on a reserving basis of GAO policyholders' entitlement to top up their existing policies or to appreciate the consequences of this entitlement. Insufficient preparatory work by FSA carried out without evident need of its policyholders' reasonable expectations. The FSA inadequately prepared for the decision in the House of Lords, paragraph 6.15.1, and also the FSA should have been better prepared in the event Equitable Life would be unable to find a buyer, paragraph 6.16.3. Is that not quite a catalogue of events for the FSA to have overlooked?
  (Sir Howard Davies) You quote accurately from the report, Chairman, but what you do not quote is that the report says quite explicitly that these criticisms are made with the benefit of hindsight and, furthermore, the report says that when we took over the regulation of the Society there was nothing which could have been done by the FSA to alter substantially the eventual outcome.

  8. I will put it to you, Sir Howard, that you were at a meeting on 5th December 1998 when you were taking over this issue, these have followed since then so rather than the die being cast at a particular time, rather than hindsight being proffered by yourself as a reason, is it not the case that the FSA should have got involved in that straight away and the warning signs with the meeting at the Treasury were there for you and everyone else to see? It should have been the primary consideration of the FSA?
  (Sir Howard Davies) The FSA did get involved directly. We did pursue a resolute approach with the company in spite of the fact that the company resisted our attentions. The company went ahead with a court case without consulting us. The company resisted us at every turn, complained to ministers, threatened judicial review. We pursued a resolute approach to dealing with the company's prudential problems. I accept that the report suggests that there were ways in which this could have been handled differently, more effectively, but it does say that the eventual outcome would not have been changed. I am afraid here, Chairman, we were dealing with a company which had an arrogant superiority, also that is quoted in the report, did not deal with the regulator in the way we would expect. Quite out of character with the relationship that we have with most firms, certainly with most banks and, indeed, increasingly with most insurance firms. These were difficult issues to deal with and also against a changing legal background where, as we have accepted in previous hearings before this Committee, we did not expect the House of Lords' outcome, we have acknowledged that. Against that very difficult legal background, we considered that we wrestled with these prudential issues, sought to do what we could to strengthen the balance sheet of the society during that period, but against a background which was extremely difficult and where the changing legal circumstances made that work somewhat nugatory.

  9. So I can take it from that, Sir Howard, you are saying "it ain't to do with us. It is because it is an arrogant company, Equitable Life, and we could do absolutely nothing about it". That is the distillation of your comments to me this morning.
  (Sir Howard Davies) I think that would be an unfair characterisation of what I am saying, Chairman. The Authority, my Board, has acknowledged that the report made pertinent criticisms of the way we managed ourselves during this period. We have published this report because we believe that it is in the public interest to do so. My Board commissioned this report and supplied it to the Treasury of its own volition because it considered that we should be an open and accountable regulator and that it is better to set out what we have done and what we have not done even if that creates uncomfortable publicity for us because it demonstrates things were not handled perfectly. Your question is whether that amounts to a finding that we have fundamentally failed the policyholders. I do not believe that it amounts to such a finding. I do not believe you can find that conclusion in the report so I am perfectly happy to sit here and acknowledge that things could have been better handled. I wish they had been better handled. I think some of the recommendations that the report makes as to how we could deal with these kind of cases are very pertinent and, indeed, as I read the report I did frequently think I wish I had acted differently in those circumstances. However, I do not think that amounts to an admission that our own inadequacies produced the problems that the company is currently in.

  10. There is a teeny weeny bit of culpability on the FSA's part?
  (Sir Howard Davies) There is a failing of management in the FSA which we acknowledge but there is also a significant problem with the regulatory regime because I have to point out to the Committee that the company met its regulatory requirements during this period. It was not insolvent. Its reinsurance was consistent with the rules and the European rules in place. Its reserving was consistent with the rules. Therefore, what we are saying also in this report, or what this report is saying, is that there is a problem with the regime in that you can have a company which meets all the existing requirements but still ends up in serious trouble. So I really do think you have to look at both of these things together, at what the Authority and the regulators did and did not do and also at the legal regime and the regulatory regime within which they were operating. We accept in this report that we could have done better in terms of our management but we also accept that there are problems with the regime itself which need to be addressed.

  11. I think you leave me more alarmed at the end than at the beginning of my questions. What you are saying now is there are significant problems with the regulatory regime, companies can comply with that but they can still get into a bit of trouble. That being the case I think we will see a lot of each other as a Committee and yourself until we get this regulatory regime correct.
  (Sir Howard Davies) Chairman, if I could respond briefly to that. That is something we would very much welcome because the changes that are recommended in Chapter 7 of this report are serious and fundamental changes which will in some cases change the practices of this industry in quite a fundamental way. For example, in relation to reinsurance, there is legitimate reinsurance going on in the insurance industry but there is also financial reinsurance which we regard now, having looked at this case in some depth, as little better than window dressing. Companies will have to change their practices and this will impose some costs and it will alter what is going on in the life insurance industry and we will need support for that, I fear, because I suspect we will get some resistence.

  12. I can assume you have robustly produced comments in evidence to Ministers on that particular issue?
  (Sir Howard Davies) The position is that most of these changes will be for us to make post N2 under the Financial Services and Markets Act. We are not at this point looking for Ministers to change the regime for the next four weeks. We are looking to put in place after N2 a regime which better meets the needs of policyholders for the future.

Mr Tyrie

  13. I would just like to clear up one point about the reduction in your bonus, Sir Howard. You did say that you thought there was some culpability of the management.
  (Sir Howard Davies) No, I do not think I used the word culpability at all actually, I think I rather resisted that word, I am afraid. I said that there were management failings. Culpability implies some crime at the end of them.

  14. Was the bonus cut in any way connected to the discovery of those management failings?
  (Sir Howard Davies) No, it was not, because as I have pointed out that decision was made in January of this year in relation to the overall performance of the Authority and the overall reputation of the Authority in the previous 12 months. Therefore, at that point the Baird Report had barely begun.

  15. So you are saying that the reputational damage to the FSA had already been done, or some had been done, even before the Equitable Life issue came into the public domain?
  (Sir Howard Davies) No, I am not saying that at all. The Equitable Life issue came into the public domain through the year 2000.

  16. Is there any connection at all between the Equitable Life issue and the bonus?
  (Sir Howard Davies) Yes.

  17. Right. How much? Can you explain the connection?
  (Sir Howard Davies) I do find this very difficult, I have to say, Mr Tyrie, because I am not responsible for determining my own bonus. I can say that the remuneration committee determined a lower bonus rate for the executive directors in recognition of the difficulties that the Authority had experienced during the year 2000. They felt that since that had caused questions about the effectiveness of the Authority in relation to Equitable Life in particular that it would not be understood in the public domain if they were prepared to ignore all of that and pay the same bonus as they had in the previous year. They believed that the Authority should recognise that reasonable questions had been raised about its effectiveness and its management and that it should recognise those in determining its overall bonus judgment. That was an overall bonus judgment, as I understood it, and not related to any specific events or failings. That really is not the way a remuneration committee would normally operate. If you wish to pursue the details of this point I will have to refer you to the Chairman of the remuneration committee.

  18. I realise that you might feel some difficulty in discussing it and I realise that some of this may upset you but what I want to get at is at the moment the FSA is exempt from fines, the FSA is exempt from all forms of actions virtually.
  (Sir Howard Davies) No, that is not really the case, Mr Tyrie. We have a statutory immunity but we are certainly not exempt from actions taken in bad faith.

  19. Except in cases of bad faith.
  (Sir Howard Davies) I should have known you knew this.

previous page contents next page

House of Commons home page Parliament home page House of Lords home page search page enquiries index

© Parliamentary copyright 2001
Prepared 17 December 2001