Select Committee on Treasury Minutes of Evidence

Examination of Witnesses (Questions 40-59)



Kali Mountford

  40. Sir Howard, given your answers to the Chair and in particular to David Laws, and your frank admission that you did not actually expect the House of Lords outcome, and your admission that things were not handled perfectly, it is hard to see how policyholders could have realised their own expectations. What do you now see as your role in protecting policyholders, particularly with their reasonable expectations, given what you have just said about the guaranteed annuity rate?
  (Sir Howard Davies) We must work as quickly as possible towards a prudential disclosure regime first, which more accurately reflects the risks and vulnerabilities in each fund. There are several recommendations in the report which speak to that point but I think that probably our consideration will not be limited to those recommendations. We have some other ideas that we want to pursue as well. We would like first of all to make regulatory returns more transparent and give the market and individuals but also those who act for individuals (IFAs etc) a better ability to understand the safety and soundness of that particular fund. Secondly, we are working to try to improve the comparative information available to policyholders so that they can make better informed decisions. We have begun with our comparative information tables in which this Committee have shown some interest in the past. We launched those formally a couple of weeks ago with one set of products, unit trust ISAs, but we will be expanding that so that over time people will be able to look to the FSA for objective comparative information on a range of products that they might want to buy. In addition to that we are expanding our consumer education work so that people know how to interpret this information or can get advice on how to interpret it more easily and more effectively than they have in the past. We hope that by working in these two ways, one, increasing the transparency of the funds themselves, and two, by increasing the consumer friendly nature of the information available to investors, we can over time improve the position, but I recognise that this is a long term project.

  41. That is fine for future policyholders making a decision, but what of Equitable Life customers who have already made losses? I accept that you say that they have not lost everything because the company is not insolvent, but it is clear they have made losses where they thought they had guarantees. What is your response to that?
  (Sir Howard Davies) I am not sure about whether they have made losses where they thought they had guarantees. The Society would argue that it has not cut any guaranteed bonus rates. There are interesting arguments about individual types of policies surrounding that but I am not sure I could at this point say that people had lost guaranteed policy amounts. The future prospects for Equitable Life policyholders are very closely bound up with the compromise scheme which has been published in draft, which proposes a one-off uplift for guaranteed annuity holders of a substantial amount, 17 per cent, and a smaller one-off uplift for non-guaranteed policy holders in return for giving away the right to their guarantees. If that were to happen, if a scheme along those lines were to be agreed, then the fund should be a reasonably sound fund for the future bearing in mind that it is a closed fund which always has some drawbacks, but it should be in a much better position to guarantee a reasonable return for policyholders going forward. I think the compromise scheme is the key to that.

  42. You did not mention though any definition of PRE. It has no legal basis at all, does it? Do you think it should have?
  (Sir Howard Davies) Policyholders' reasonable expectations, as this report I think makes clear, has a somewhat chequered history and is lacking in clarity and definition. The phrase "PRE" will not be part of the new regime. We have tried to replace that with the concept of treating customers fairly and we have published a paper on what we think that means in future in terms of the information that should be provided to policyholders and the information particularly about the way in which companies will exercise their discretion. We are working on that in the context of our review of with-profits policies and we aim to produce a more comprehensive definition of what we mean by treating customers fairly in the spring of next year, but I agree that that concept has been—I will not go so far as to say unhelpful—not as clear as it should have been.

  43. So are you saying that it is a concept that has had its day?
  (Sir Howard Davies) Yes, and it has only got a month to live.


  44. Sir Howard, if we could now turn to the approach of the FSA to the legal rulings, as we all know, the first court, the Chancery Division of the High Court, upheld Equitable's view that it had sufficient discretion to grant a final bonus depending on how a policyholder decided to take his or her benefits. We know that in the Appeal Court, one judge, Lord Justice Morritt, agreed with the High Court but the other two, Lord Woolf and Lord Justice Waller, said that the Board could not award differential bonuses depending on whether the guarantee was taken up, and Lord Justice Waller spoke of ring-fencing, which was a bit different from Lord Woolf. However, in the House of Lords all five Law Lords decided that Equitable was not entitled to award different final bonuses. The Court of Appeal made its judgment on 21 January 2000. It appears from the Baird Report that there was little communication between the FSA and Equitable Life on this particular issue, and indeed Equitable Life had laid out a scenario for their lawyers as to how the court case would go. There were six elements to that. The first was complete success on the part of Equitable Life. The second was success but some adverse comment in the judgment. The third was that directors have discretion but have incorrectly executed it on technical grounds. The fourth was that directors have discretion but have not given sufficient weight to or considered the right PRE etc. The fifth was that the Society's approach was invalid and that final bonus rates on cash and annuity benefits must be equal, and the sixth was that the Society's approach was invalid. The lawyers discounted the latter four and said that the only ones worthy of consideration were the first two, ie complete success by Equitable Life or success but some adverse comment in the judgment. In the Court of Appeal case verdict on 21 January 2000 the Master of the Rolls, the most distinguished judge, the most senior judge, Lord Woolf, made his comments known, and if we look to the Baird Report appendix it says very clearly that Lord Woolf's judgment was a declaration that a differential final bonus was not a permissible exercise of the discretion conferred by Article 65 of the Society's Articles. Why then did the FSA in essence discount the reasoning of the Court of Appeal judgment and in particular the judgment of the lead judge, the Master of the Rolls, Lord Woolf?
  (Sir Howard Davies) I am not sure that we did discount that judgment. This is of course a case where (and after the first case when we had the Vice Chancellor's very firm judgment) at one point we felt we had a firm position based on Sir Richard Scott's judgment. However, I think the key was that the Court of Appeal judgment was addressing the question of whether it was possible to award differential bonuses depending on whether or not you took up the guarantee. That was the point you made at the beginning of your question, Chairman. That did not mean as we understood it that the Society would need to award exactly the same bonus to all of the guaranteed and the non-guaranteed policyholders but it would be possible to use that judgment to award some differential bonuses, albeit you could not within the class of guaranteed policyholders award differential bonuses there. Therefore it would not have the serious effects on the Society's financial position that the House of Lords' judgment had, which was different. Therefore we did think that if the Court of Appeal judgment was upheld that was a position which the Society could manage within its resources. It was the House of Lords judgment which went further than that and said there was no possibility at all of differential bonuses that was not something that was expected.

  45. Can I remind you, Sir Howard, that Lord Justice Woolf on the 21 January was very clear when he said, and I repeat it, that the declaration of a differential final bonus was not a permissible exercise. If I refer you to the Baird Report, page 140, paragraph 4.53.5, that says that from the documents seen by the Review Team [the Baird team], there was no communication between the Insurance Financial Services Division of the FSA and Equitable Life between mid January 2000 when the Court of Appeal decision was published and late May 2000 relating to the court case.
  (Sir Howard Davies) Yes.

  46. That five months' inactivity seems staggeringly complacent and it would indicate that really not much cognisance was given to Lord Justice Woolf's comments. Incidentally, all five Law Lords agreed with Lord Justice Woolf. Here was a train coming down the line at 120 miles an hour and people walked away from the station for five months and did not communicate. It seems inexplicable, Sir Howard.
  (Sir Howard Davies) I hoped we were not going to talk about the railways today.

  47. We will come on to that.
  (Sir Howard Davies) The judgment in 4.53.3, which was reported to our Board, was that if the appeal judgment was upheld Equitable would need to revise its bonus policy but potentially the new approach need not lead to significant additional costs. That was because our interpretation of the Court of Appeal judgment was that it would not be possible for them to have differential bonuses for people who took up the guarantee or did not take up the guarantee, but it would not be absolutely necessary to have exactly the same bonus for the guaranteed and non-guaranteed policyholders. Therefore, the House of Lords judgment went further. The position that we were looking at during that period was whether or not the Court of Appeal judgment would be upheld, and we thought that on the basis of the argumentation in 4.53.3 it would be possible for the company to go on if the Court of Appeal judgment was upheld.

  48. With all due respect, Sir Howard, I did not read out the rest of Lord Woolf's judgment for the sake of time, but I think I will read it out now. It says: "The powers contained in that provision [Article 65] were not conferred for the purpose of treating a policyholder differently depending on the manner in which he sought to exercise his rights under the policy. Yet that was precisely the result of the policy adopted by the society and that was a collateral purpose designed to negative a benefit to which the policyholder would otherwise have been entitled." So, rather than the Court of Appeal and Lord Justice Woolf going beyond the House of Lords judgement, it was the clarity with which Lord Justice Woolf expressed that which was taken up by the Law Lords, and therefore it was the same implication that was made, so I would suggest that it is wrong to imply that it went further. Indeed Lord Justice Woolf hit the nail on the head on the 21 January 2000 and it seemed that nobody took that on.
  (Sir Howard Davies) With respect, Chairman, that was not our interpretation. Indeed, the additional bit of the judgment which you read out really speaks to the question of whether it was possible to do what the Equitable had been doing, which was to award a different bonus rate whether or not the guaranteed annuity policyholder had taken up the guarantee or not. That was certainly outlawed. If I could refer you to 4.55.8 on page 142, at that point (this was on 4 July) a third scenario which is described as "this new third scenario" was now in play: "A ruling that did not allow the Society to alter the rate of bonus for policies that contain GARs—the Society would need to declare a rate of bonus as if the policies did not contain GARs. This would mean that the Equitable would have to pay a GA [guaranteed annuity] on top of unadjusted asset share; the directors of the Society would not be able to adjust bonus rates downward because GAR benefits gave an additional benefit to the policyholder." We had thought in the light of the Court of Appeal judgment that that would still be possible based on the view that had been taken right at the outset, which is referred to as a Government Actuary's Department view, which was that it was reasonable, and that was in the Treasury's letter of December 1998, that it was reasonable for a company to extract some charge for the guarantee. The House of Lords judgment was a different scenario as we saw it from the Lord Woolf judgment. The Lord Woolf judgment did not appear to us to have catastrophic effects for the finances of the Society.

  49. It seems to me as a non-lawyer that in very plain English Lord Justice Woolf is saying that the powers were not conferred for treating a policyholder differently.
  (Sir Howard Davies) Depending on what choice he made. That is quite right. I agree with that, but we are talking about GARs as a group and non-GARs as a group.

  50. I understand.
  (Sir Howard Davies) He is saying that within the GARs as a group you may not differentiate between those who choose to take the guaranteed annuity and those who do not.

  51. Can you explain why there was no communication for five months after the Court of Appeal judgment?
  (Sir Howard Davies) It was simply because the case was being prepared for reviewing and nothing new had happened. Nothing new happened until the House of Lords hearing actually took place.

Mr Ruffley

  52. Continuing this line of questions, Baird makes clear that you placed too much reliance on obiter dicta in the Court of Appeal from Lord Justice Waller regarding ring fencing. Why did you do that? It is page 216, paragraph 6.15.5.
  (Sir Howard Davies) I think this is the same point.

  53. No, with respect it is not. It is developing the point. Can you answer the question? The obiter dicta point has not been touched on by the Chairman so it is a fresh point on that question. What is the answer? Why did you place so much reliance on obiter dicta which did not form part of the proper decision?
  (Sir Howard Davies) We would not accept that we placed too much reliance on it. We were seeking to interpret the appeal judgment and how the company could operate within it. I think that we believed that the combination of the Lord Woolf judgment and the Lord Justice Waller judgment would allow the company to have differential bonuses for GARs as a whole. We took those two judgments together.

  54. Yes, and you came to the dud conclusion, did you not?
  (Sir Howard Davies) I do not see how you can possibly say it was a dud conclusion, Mr Ruffley, because that is not the position that we ended up at. The House of Lords took a different view. If the House of Lords had taken the Court of Appeal's view we think that it would have been possible for the Equitable to have taken that different approach.

  55. With respect, it was dud in the sense that the House of Lords came to the conclusion that you and your lawyers did not counsel it. You got it wrong.
  (Sir Howard Davies) You have changed your accusation there, Mr Ruffley, in the course of that. You said to me that that was a dud conclusion that we interpreted the Court of Appeal judgment in the way we did. That was not the case. We believed that interpretation was correct. The judgment then changed.

  56. Falsified by the decision of the House of Lords.
  (Sir Howard Davies) The judgment was a different one in the House of Lords.

  57. In what sense?
  (Sir Howard Davies) It was different because it said, as I pointed out, on 4.55.3, that you could not — I think it was 4.55.3—

  58. Your decision about what was going to happen after the Court of Appeal was wrong. You did not see the House of Lords ruling coming. You were coming to dud conclusions after the Court of Appeal by definition because you did not call it right from the House of Lords, did you, Sir Howard?
  (Sir Howard Davies) That is right. We did not call the House of Lords right. I agree with that, but that is a different point.

  59. That is what I am saying.
  (Sir Howard Davies) That is a different point.

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